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Bailout Failure and Investing in America's Future

Stock-Markets / Credit Crisis Bailouts Nov 05, 2008 - 07:17 AM GMT

By: Money_and_Markets


Diamond Rated - Best Financial Markets Analysis ArticleSean Brodrick writes: By the time you read this, America will have a new President. I hope he's better with money than the last resident of the White House. Just look at how the Bush gang is spending the $700 billion bailout package for banks — throwing it at financial institutions with few strings attached.

As a result, many Wall Street institutions are using billions and billions of taxpayer dollars to pay for fat cats' bonuses.

  • Goldman Sachs, which is getting $10 billion from the bailout plan, is paying out $6.85 billion in bonuses, according to media reports. That's $210,000 per employee. And that's despite a 47% drop in its profit and 53% drop in its share price.
  • Morgan Stanley, which is also getting $10 billion from our government, is doling out $6.44 billion in bonuses or $138,700 per employee, even though its profits tumbled 41% and its shares are off by 69%.
  • And even the failures at Lehman Brothers are collectively getting over $1 billion in bonuses.
Buffett played his cards right and got a heck of a deal.
Buffett played his cards right and got a heck of a deal.

Some conservatives have been bemoaning the “nationalization” of America's big banks. Yet we didn't nationalize anything — we don't control those banks. They're free to spend the bailout money as they please.

And we got hosed.

If Only We Got A Deal Like Buffett Did …

Just compare the deal Uncle Sam got for Goldman Sachs shares to the deal Warren Buffett made.

Warren Buffett invested $5 billion in Goldman Sachs in return for preferred stock and warrants to purchase common stock in the future. Buffett's preferred shares pay a sweet 10% dividend.

But Goldman and the other big financial institutions needed more money to cover their bad bets.

So, 20 days later, Treasury Secretary Hank Paulson came along and made an investment for preferred stock and warrants in nine banks. Only the government's preferred shares pay a measly 5% dividend.

Henry Paulson
Thanks for looking out for us, Hank!

It gets worse …

United Steelworkers Union president Leo Gerard recently wrote in a letter to Paulson that seems to ooze anger:

“Dollar for dollar, Buffett received at least seven and perhaps up to 14 times more warrants than the Treasury did, and his warrants have more favorable terms.”

Is it relevant that Paulson used to be the head of Goldman Sachs, one of the financials being bailed out?

Heck yeah!

Under his stewardship, Uncle Sam ended up paying $125 billon for what Warren Buffett thought was worth just $62.5 billion.

If the rest of the $700 billion bailout is dispersed using the same math, we'll be gifting $350 billion to America's biggest bankers — those bonuses have to come from somewhere — and then overpaying for what the other $350 billion buys us.

One Thing the Banks Are Not Doing With the Money:
Loaning It Out Like They Were Supposed To …

In their defense, the banks are saying that no one is queuing up for loans. Su-u-u-u-re. Just tell that to any auto dealer who can't get money together to make payroll.

One place where big investment houses and banks did decide to put money to work was in shorting stocks.

A bunch of financial firms lined up to short Volkswagen. It seemed like a smart move, right? Cars sales are tanking. Problem is, at the same time, Porsche was stealthily buying Volkswagen shares until it acquired a controlling interest. Then the short squeeze was on. Those bailed-out firms suddenly had to cover their short positions and lost billions of dollars.

Some of them lost more on the Volkswagen deal than they ever lost on Lehman Brothers imploding!

The banks' post-bailout behavior — no loans, blowing bailout money on bad investments — irked Barney Frank, chairman of the U.S. House of Representatives Financial Services Committee, one of the people who helped Paulson ram the Emergency Economic Stabilization Act of 2008 (EESA) through Congress.

Frank is supposed to be one of the “smart ones” in Congress. Here's what he had to say:

“I am deeply disappointed that a number of financial institutions are distorting the legislation that Congress passed at the President's request to respond to the credit crisis by making funds available for increased lending. Any use of these funds for any purpose other than lending — for bonuses, for severance pay, for dividends, for acquisitions of other institutions, etc. — is a violation of the terms of the Act.”

Nice words. Too bad they're as hollow as a rotten log.

The language of the bailout does talk about homeowner assistance … limit executive pay … provide for government audits … etc. But it doesn't dictate serious limits on how the banks can use the money. Barney Frank may have thought he had an understanding with Paulson, Fed Chairman Ben Bernanke and the big banks.

But that's like having an understanding with Al Capone.

Seriously … If Frank is as smart as everyone says he is, and he's making a deal with banks that have already shown they're capable of blowing hundreds of billions of dollars on derivatives, shouldn't he demand what he expects from them in writing before handing them a big bag of our money?

I guess I shouldn't single out Congressman Frank. Plenty of others in Congress went along with Paulson's plan. They say you get the leaders you deserve. But did we really deserve this?

The $700 Billion Bailout Is a BIG, FAT FAILURE!

Have you heard the chuckleheads on CNBC line up to say: “The government can end up making money on this bailout”?

Sure, when pigs fly!

The plan is that as the housing market recovers, the government will sell its holdings — all that worthless mortgage paper from the banks — and recoup its money. Never mind that many of those mortgages will never pay off … that there was outright fraud … that inflation is going to eat up any remaining value of the collateralized debt obligations.

In short, this plan won't work.

The sad thing is this $700 billion financial Frankenstein is just a drop in the bucket of the wholesale looting of the public purse that has gone on under the Bush Administration. Over the past eight years, Bush added approximately $5 trillion to the national debt ceiling.

The point of my rant here is that the U.S. government has blown $700 billion — and much more — bailing out criminals in pin-striped suits who got themselves into a multi-billion-dollar mess of their own devising, and then they insist on giving themselves bonuses !

It's High Time to Stop Bailing Out These Bums …

There is going to be another bailout. I know, after all the facts I've laid out for you here, you probably want another government bailout like you want to have your liver extracted by a guy with a switchblade.

But as long as Washington can print money, they'll throw it at problems. So I have a suggestion for the next President: Stop bailing out Wall Street fat cats.

I don't care how much they scream about how they're the underpinning of America's financial system. If Wall Street bankers cannot survive after all the money we've thrown at them, tell them to drop off the banks' keys at the U.S. Capitol. We'll find someone else who can do the job.

And while we still have some money left in the Treasury … while the U.S. dollar still holds some value … please spend the money on something useful.

3 Ways to Spend the Next Bailout Package,
And Create New American Jobs That Can't Be Shipped Overseas …

I know that the next President will be tempted to bail out the consumer. After all, Wall Street got its loot. So why shouldn't America's middle class?

And consider …

  • Nearly one in five U.S. mortgage borrowers owe more to lenders than their homes are worth. And the rate may soon approach one in four. About 7.63 million properties, or 18%, had negative equity in September, according to a report by First American CoreLogic.
  • Manufacturing in the U.S. contracted in October at the fastest pace in 26 years.
  • Over one million jobs have been lost in the last 12 months. In September, another 159,000 jobs disappeared.

Never mind recession — we could be headed for Depression.

The Reuters-Jefferies CRB Index of Raw Industrials, a gauge of the cost of 22 items including scrap copper, cotton and hogs, is a good indicator of economic health.

Plunge in CRB Raw Materials Index: A sign of worse to come for the economy?

During the eight-month recession that began in March 2001, this index fell 8.7% as U.S. industrial production dropped as much as 5.7%. The industrial-commodity index fell 19% during the recession that began in July 1981, as factory production plunged as much as 7.1%.

How much has it fallen now? A whopping 31%, and factory production has only fallen 2.8% … so far. Again, that means much worse is likely to come.

So I know that it will be tempting for the new American President to provide “mortgage relief” and prevent foreclosures.

But … that would just be propping up the same failed system that Wall Street hoodwinked us with in the first place. Our housing market needs to fail — so prices can find a new base and economic activity can start again.

And throwing billions and billions of dollars at consumer debt would just send it into the same black hole that Wall Street knows so well.

So how would I spend the next bailout package?

Here are three ideas:

1) Rebuild the nation's power grid …

We need an efficient power grid that can carry renewable energy — solar from the Mojave Desert and wind from the Great Plains — to the population centers of the U.S. Too bad our power grid is 100 years old and falling apart at the seams. And demand is growing every year.

Upgrading the grid brings multiple benefits: Along with fewer catastrophic failures, we should also see a 15% reduction in total demand through real-time incentives and a 20% drop through smart appliances. And vehicle-to-grid (V2G) cars that charge at off-peak times during the night, then share any excess power stored in their batteries with the grid during the day, would enable the U.S. power grid to shift as much as 50% of its energy to intermittent sources like wind and solar power.

2) Rebuild, expand and electrify America's railroads …

There are already proposals for a “second bailout package” to build more highways and bridges. While I'm all in favor of repairing America's existing bridges, we don't need more highways for oil-dependent cars. We need more railroads for an energy independent America — building those lines is a good bottom-up way to boost the economy.

We could electrify all 36,000 of America's main railroad lines for about $90 billion. It would also save about 185,000 barrels of oil per day. And every train we can take off diesel fuel brings us one step closer to telling the oil-rich sheiks where they can shove their barrels of oil.

3) Fund a “moon-shot” electric car program …

I'm talking about developing mass-market battery-powered cars (hybrid or plug-in) that achieve at least 100 mpg of gasoline on new fleets by the year 2015.

The Chevy Volt is designed to move more than 75 percent of America's daily commuters without a single drop of gas.
The Chevy Volt is designed to move more than 75 percent of America's daily commuters without a single drop of gas.

There have been some steps in the right direction on this. As part of the EESA bailout, the U.S. passed the Energy Improvement and Extension Act of 2008 — a fancy-pants way of saying a tax credit for hybrid vehicles. It provides up to $7,500 per vehicle for the first 250,000 cars. That's a maximum of $1.88 billion. That's less than one-fifth of what Goldman Sachs got in the bank bailout.

And the Department of Energy recently awarded $30 million to Ford, GM and General Electric to develop and demonstrate plug-in hybrid electric vehicles. Come on … just $30 million? There are individual Wall Street bankers who get bigger bonuses than that!

Bottom line: We'd better start investing in our transportation future, or it will be a long time waiting for the bus to come along.

All three of the programs I've outlined above have one thing in common: Good American jobs that can't be shipped overseas. If you want to jump-start the economy, that's a 1-2-3 that might work.

The American Society of Civil Engineers (ASCE) has estimated that the country needs to spend $1.6 trillion over five years to fix our infrastructure, from dilapidated levees to congested roadways and ports.

Sure, $1.6 trillion is a nice start. But if you add up all the various bailouts that the government has thrown at the global financial system, you get closer to $2 trillion. Is America's energy future more important than keeping the fat cats purring?

I think so.

Invest for America's Future, And Get Richer Along the Way …

If America wakes up and goes whole-hog for energy independence, and starts funding the energy grid, electrified rail and electric cars, there are some investments that should do really well:

  • Market Vectors Global Alternative Energy Fund (GEX). It holds companies including First Solar, Vestas Wind System, and international technology and energy companies.
  • PowerShares Global Wind Energy (PWND). This contains Mitsubishi Heavy Industries, ABB Ltd (a powergrid infrastructure play), Gamesa Corp (a wind turbine manufacturer) and more.
  • SPDR FTSE/Macquarie Global Infrastructure (GII). This fund holds E.ON AG, Iberdrola SA, Exelon Corp, and other builders and operators of the global energy infrastructure.
  • iPath Dow Jones-AIG Nickel Commodity ETF (JJN). This tracks the price of nickel, a metal used in electric car batteries. It's been sold hard as commodities crashed, and would also be a good pick if and when commodities bottom.

Here's hoping a new administration decides to fund the future, not the fat cats.

All the best,


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