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Bailout Plan No Solution to America's Ponzi Scheme Economy

Politics / Credit Crisis Bailouts Sep 29, 2008 - 03:07 AM GMT

By: Mike_Stathis

Politics Diamond Rated - Best Financial Markets Analysis ArticleRisks of the Proposed Bailout: Part II - Would I support a bailout under any circumstances? Maybe. But only if there was a clear plan laid forth with specific guidelines and it was to be executed by credible and competent leaders. And only after I saw dozens of bank, Wall Street, and mortgage CEOs and others have their assets stripped and sent to prison. But all of Washington has been way behind the curve the entire time. And they have not raised the issue of accountability as I define it.

Even the Securities and Exchange Commission (the agency created during the last depression to regulate the U.S. capital markets) has been asleep on the job. SEC Chairman Chris Cox allowed naked short selling ever since he took the position in 2005, as have all others before him despite the fact that naked shorting is illegal. He sat by while watching the accelerated destruction of the banks due to massive naked short selling. Even his first list preventing naked shorting of 19 banks was ineffective since it didn't include the banks most at risk – Washington Mutual, Wachovia and E-Trade – the guys with short interest ratios over 25%.

By the time Cox issued a temporary ban on shorting 799 financials, the destruction was already finished and the bailout wave accelerated. Cox should clearly be brought up on some harsh charges due to negligence if not fraud. Along with Killinger, the Office of Thrift Supervision and the insiders who clearly made money from selling Washington Mutual prior to the official announcement, Chairman Cox should be brought up on criminal charges. I'll get back to the Washington Mutual debacle in a few days.

When we speak of trust, it's important to consider two separate aspects of the term. First there's a trust in judgment or competence. Having trust in one's judgment is mandatory but insufficient for someone in a high position of responsibility. But without trust in one's integrity you can throw the best judgment out the door. Thus, honesty and good intentions are also necessary but insufficient requirements. Only by having a complete trust in those who would be heading this bailout can Americans move forward with confidence. The question is….can you trust Paulson and Bernanke? Do you trust their judgment and have confidence in their honesty? Let me help you decide.

Paulson is asking for the unprecedented responsibility to carry out the proposed bailout with very little transparency and no clear plan. I suppose he thinks he can improvise his way through this mess. I have a great deal of concern not only for the lack of a clear strategy but also due to his Wall Street ties. We must therefore question the possibility whether handing Paulson a blank check will actually lead to worse consequences. In my opinion it will.

How can anyone trust the guys who failed to regulate the banks? Bernanke will most likely also play a central role in this plan. In fact, he might play a larger role if Paulson is replaced next year. Neither had a clue what was going on. Yet, magically Bernanke and Paulson are now on top of the situation? You mean to tell me that Paulson and Bernanke all of the sudden have a full grasp of the danger and have solutions ready in place? If so, we need to see it in writing. These are the same individuals who continued to downplay the crisis for over a year ever since it was obvious. That's what I call behind the curve.

  • May 2007, Bernanke said the financial system would be able to "absorb the losses from this subprime mortgage problem" without difficulty.
  • “we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system."
  • April 2007, Paulson said he didn't see subprime "imposing a serious problem"
  • Paulson continued to insist there would be no bailouts for “reckless lenders all throughout 2008 – even just a few weeks before he decided to bail out Fannie and Freddie. Then a few weeks later, while on the verge of collapse, he stated the same thing about AIG only to announce a bailout a few days later.

Paulson: we must now take further, decisive action to fundamentally and comprehensively address the root cause of our financial system's stresses.”

This plan has absolutely nothing to do with addressing the root cause of “our financial system's stresses.” He is saying it will take $700 billion to address the root causes. Instead of a $700 billion price tag, I'll “address the root cause of our financial system's stresses” for free. The root cause is embedded in America 's Ponzi scheme economy and an unregulated financial system filled with greedy and dishonest individuals who do not feel the threat of criminal prosecution. Note the wording used by Paulson. He wants to make the public think that the plan will fix the fundamental problems.

Bernanke: if this plan is not passed it will stifle the credit markets, leading to higher unemployment, lower GDP, etc. What he is not telling you is that even if the plan is passed, we are going to see the same fate. If he doesn't realize this, he should resign.

How can we trust these men? They are either clueless or liars; perhaps both. I could care less that Paulson led Goldman Sachs. On Wall Street the saying is “You're only as good as your last call.” And Paulson really missed this one bad. In fact, it are his ties to Wall Street that concern me. As for Bernanke, what can you say about a man who spent his entire life sheltered from the realities of the real world? It is clear that he either has no idea what he is doing or else he does not care about protecting consumers from the devastating affects of inflation. I'll let you decide.

Blind Man's Bluff

Most of us have played Blind Man's Bluff as children. It's such a popular game among kids that it has several versions. A person is blindfolded and has the distinct designation of being referred to as “it.” Everyone runs around trying to avoid being touched (tagged) by this person (it). For if they are tagged they lose the game and become spectators. The game continues until “it” has tagged everyone. In another version, “it” attempts to identify the person tagged by feeling their face. If the person is correctly identified by “it” that person is eliminated from the game.

The bailout plan has a striking resemblance to Blind Man's Bluff, except the game will take a very long time to end because the Treasury will be running around blind, not knowing what kind of debt they are buying or how to manage it. Washington has no way to identify the true nature of the banks' debt. Therefore, they won't be able to fully assess or manage risk. The banks aren't even able to do this, yet the Treasury will succeed? Most likely the Treasury Secretary will be running around for many years blindly throwing taxpayer money at the financial system. The only winners will be the banks and those who buy bank debt from the Treasury.

Big Bailout, Big Problems

It would not only be highly irresponsible to pass such a plan, but also potentially disastrous. We are talking about a plan less than 3 pages in length. Something of this magnitude should be at least 500 pages for a basic description alone. All we really know is how the auction would proceed. Under the proposed plan, a Dutch auction would take place whereby the buyer (the U.S. Treasury) would lay out guidelines of debt securities it wanted to purchase in terms of the type, amounts, etc. The sellers would be the banks who would each offer a price. All prices would be filled until the amount asked for was filled.

But this process assumes the Treasury would be able to properly value the debt – something that in many cases would be impossible to determine. And if the Treasury does not offer a price the banks feel is fair, they may decide not to sell much of this debt. This could force the Treasury to pay very high prices for these junk bonds, ensuring massive losses to taxpayers.

Also consider that banks will sell off only their worst junk bonds – bonds that have the highest chance of losing it all.

I will guarantee you most if not all of the debt purchased by the Treasury will need to be marked down many times over. That means they will have to apply a huge discount to this junk yard of debt securities. And banks might not agree to such discounts. But there would be no bluffing game because the banks know the Treasury's main purpose is to clean up their balance sheets to unlock the credit markets. In the end, the banks will get a good price at the expense of taxpayers.

After trying to figure out what they have and how much it's worth now for over a year, even the banks don't have a clue. Are we to believe Paulson does? His approach would value these securities on a future value basis. Future value? He future value could be zero.

Anyone who thinks this bailout will be limited to $700 billion or any figure Washington decides on is naïve. In my view it will cost taxpayers at minimum $3 trillion and possibly $5 trillion. As well, it's likely Paulson will be replaced by the new president, although if McCain wins there is a fairly good chance he will keep him as someone to blame him when the catastrophe unfolds. Let's say Paulson is replaced. We will then have a new Treasury Secretary who has no experience in this crisis with a blank check.

Perhaps the most laughable part of the plan is its two-year limit. Once again, thoughts of the invasion of Iraq come to mind. The RTC spawned from the S&L Crisis took six years and grew from an initial $50 billion to over $150 billion by the time it was finished. The Reconstruction Finance Corporation born during the Great Depression lasted for two decades.

There are simply too many unanswered questions and risks with no assurances whatsoever. We've learned some valuable lessons from Iraq . Without adequate preparation and a defined strategy, America will most certainly be worse off entering the financial black hole with essentially one person having a blank check but with no clear plan. If the bailout is passed in its current form, it's likely to create more problems than it solves. If the plan is rejected or modified in a way that comes up short of Washington 's requirements, you better believe the next administration will blame the inevitable meltdown on those who did not support passage of what is currently a reckless plan.

Big Investors Already Drooling

“Warren Buffett called the $700 billion U.S. bailout plan ‘absolutely necessary' to help pull the financial system out of an "economic Pearl Harbor ." Easy for him to say.

The plan has not even been passed and Buffett has already taken a stake in Goldman Sachs. What kind of investor would give the green light to an administration that was in the dark and had no idea what was going on? What kind of investor would endorse a 2-page plan that ensures an ultimate cost of trillions, with no details, no rules or guidelines? An opportunistic investor who stands to gain through buying assets directly from the U.S. Treasury and investing in banks that will replace junk bonds with taxpayer dollars.

It's a great investment opportunity for the guys with big money. Taxpayers will clean up the banking mess. Then big investors will pour in huge amounts of investment capital and reap big rewards. Make no mistake; this is a bailout not only for the banks but for all who will buy the debt from the Treasury and take ownership stakes in them. It will be taxpayer-funded support for private investments such as those run by Warren Buffett, Bill Gross and others.


Is there a free market solution? Definitely. Would it require some form of government assistance? Without a doubt. But to hand a man who refuses to outline any real details; a man who has preached no bailouts over and over only to change his mind; a man who obviously has not had a good handle on the situation; a man who is likely to favor his Wall Street friends - is dangerous. Free market economics works great. The only problem is that America hasn't operated in a true free market system for many years. This is unlikely to change without a radical restructuring of economic, trade and tax policies. But we must also have real oversight from the SEC and much more banking regulation. Finally, those who engage in fraud or criminal neglect must face dire consequences.

Are the bank CEOs a part of the free market solution? Only if they are cornered and provided with a clear incentive so they will actually add value for a change. The fact that they were guaranteed huge compensation packages even after destroying companies is one of the reasons for this crisis. What if we give them a chance – fix this crisis and do it with minimum taxpayer money, legally, and without fraud – or send them to prison for a very long time. I'll guarantee you they would find a way. Better yet, assemble a team of business and finance leaders with proven track records to fix this mess. Replace Paulson with Lawrence Summers or Nouriel Roubini - two of the rare economists who “get it.” Or what about or John Snow? Replace Bernanke with Paul Volcker and SEC Chairman Cox with Andrew Cuomo or Eliot Spitzer. There are many others who should be leading this nation – Paul O' Neill, Colin Powell, and many others. America has some truly skillful, honest and great leaders. But they have been shut out by the Washington mafia.

Ultimately, there needs to be an international financial regulatory agency because we are now dealing with a global financial network. And we must ensure that no single financial institution becomes so large and influential that it needs a bailout. This would imply more strict anti-monopoly laws and enforcement.

Coming Up Short

Make no mistake; this bailout is for short-term liquidity only. It offers no real solutions. In fact, you better understand that it will weaken the dollar further, driving up inflation and oil prices. As well, it will, in my opinion cause more foreigners to question the credit risk of U.S. Treasuries. The bailout plan won't even offer solutions for the real estate market unless it provides some type of assistance to those facing foreclosure. But it would be impossible to help taxpayers in an equitable manner. In the best of scenarios, millions will be left out and very angry. What about those who already lost their home? What about those who struggled any way they could by taking another job, tapping into their 401(k)s, borrowing from relatives, selling assets, and other ways? These are the people who tried to pull through.

Even assistance to homeowners via low mortgages will cost a lot of taxpayer dollars, but who is to say they will be able to pay off their mortgage? The economy is weak now and was weak prior to 2007. And it's going to get weaker. The only way to improve the economy on a short- or intermediate-term basis is to keep printing money and borrowing from foreigners. But that will create the illusion of a strong economy, while positioning the U.S. for an even bigger collapse down the road.

The best way to help American's keep their homes is to create real jobs and increase wages. America needs a permanent economic solution. That means it needs a viable energy strategy, a restructuring of free trade and the free market system, and universal healthcare. Without these things, the bailout funds (that will have to be borrowed from foreigners) will just add more pain to the debt with false hopes and more profiteering by insiders. It's a theme that will continue to repeat over and over until Washington is forced to start serving the people, as mandated by the United States Constitution.

By Mike Stathis

Copyright © 2008. All Rights Reserved. Mike Stathis.

Mike Stathis is the Managing Principal of Apex Venture Advisors , a business and investment intelligence firm serving the needs of venture firms, corporations and hedge funds on a variety of projects. Mike's work in the private markets includes valuation analysis, deal structuring, and business strategy. In the public markets he has assisted hedge funds with investment strategy, valuation analysis, market forecasting, risk management, and distressed securities analysis. Prior to Apex Advisors, Mike worked at UBS and Bear Stearns, focusing on asset management and merchant banking.

The accuracy of his predictions and insights detailed in the 2006 release of America's Financial Apocalypse and Cashing in on the Real Estate Bubble have positioned him as one of America's most insightful and creative financial minds. These books serve as proof that he remains well ahead of the curve, as he continues to position his clients with a unique competitive advantage. His first book, The Startup Company Bible for Entrepreneurs has become required reading for high-tech entrepreneurs, and is used in several business schools as a required text for completion of the MBA program.

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Books Published
"America's Financial Apocalypse" (Condensed Version)

"Cashing in on the Real Estate Bubble"

"The Startup Company Bible for Entrepreneurs"

Disclaimer: All investment commentaries and recommendations herein have been presented for educational purposes, are generic and not meant to serve as individual investment advice, and should not be taken as such. Readers should consult their registered financial representative to determine the suitability of all investment strategies discussed. Without a consideration of each investor's financial profile. The investment strategies herein do not apply to 401(k), IRA or any other tax-deferred retirement accounts due to the limitations of these investment vehicles.

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