Tuesday, July 15, 2008

Corporate Socialism – The American Way?

This is the basic hypocrisy, the great American denial: The land of free trade and enterprise practices socialism at its highest levels. If you doubt me, consider the unfolding Freddie/Fannie drama.

Treasury Secretary Henry Paulson plans to ask for authority to buy equity stakes in the two largest mortgage firms and lend them capital has quelled fears among money funds. It is a very public version of insider trading, with one major difference – current equity holders will probably be wiped out.

"We assume their stock prices will go to zero - the government won't pay to buy them"

Nor should they, this very public signaling would drive an obscene level of speculation and share trading to profit from a government bail out. Well, that’s fine for the equity side of the equation, but…

Investment firms that manage more than $520 billion in money-market funds, said they will continue to buy Fannie Mae and Freddie Mac debt because the U.S. Treasury's rescue plan has bolstered confidence. These include Vanguard Group, Federated Investors Inc. and The Reserve.

The real effect is that corporations with the buying power can manipulate this public recovery plan, and receive blow by blow guidelines to maximize their potential profits. That is a form of socialism, of corporate welfare.

“The steps that the Treasury is proposing is a strong positive for the marketplace as a whole,” David Glocke (a portfolio manager for Vanguard) said in an interview. Vanguard oversees $170 billion in money funds. “We've been a big buyer and have positions in all our portfolios”

My own leaning is to providing some sort of safety net to mortgage holders, but I would hate to suggest even more socialism to the land of free trade. Given the whole problem has been greed driven, I wonder how November would shape up with millions of voters holding mortgage default notices in their hands.

Ok, the politicians aren’t going to allow that, but at least they could ensure that the big end f town was not able to profit even more from the whole mess. Instead of the corporate directors and portfolio manages rubbing their hands with glee, make sure they pay for the disaster they have created.


lindsaylobe said...

It’s yet another chapter in this saga of bad news arising from bad lending processes, what is becoming increasingly ugly.

With over 5 trillion in mortgages and only 80 Billion in capital Fannie & Freddie were always very highly leveraged, relying on house price appreciation.

Operating under an implied Government guarantee and an objective to increase the availability of home lending its high growth strategy and leveraged position meant at any time there only needed to be a few percentage unfavorable movements for all the capital to be at risk.

I understand under their government charter they are not yet technically insolvent but it seems inevitable should house prices fall further. Ironically they only have 3.5% of the book in the subprime area but that still represents an amount of 170 billion.

I would have thought a share rights issue priced at say 50% of the existing stock prices would have been more transparent, combined with say confirmation of a government guarantee.

But I also believe that government guarantee should insist on a need to revise their charter and improve prudential standards.

The USA market is one of the most heavily regulated anywhere. But it remains a complicated cocktail of private equity and implied government guarantees which is not clearly structured.

The Freddie and Fannie rescue plan has been implemented just a few days after the Federal Deposit Insurance Corporation took over IndyMac Bancorp Inc as that California Lender collapsed under soaring losses.

There is now the worry of regional Banks with heavy exposures to the housing market coming under pressure as house price reductions and foreclosures continue.

I think the Fed was rather hoping financial institions would begin to stabilize, and come to grips with their situation, but it appears to me it could be there is still much more to come. I hope not.
Meanwhile consumer prices inflation continues to climb rapidly against a back drop of official interest rates being held down at only 2-3%.
best wishes

Cart said...

Lindsay, thank you for filling it out. Still, the thing that continues to concern me is the way potential moves are being signaled so publicly.
Could you imagine the Aussie equivalents to the US Fed and legislature handling an issue like this so openly?
Mind you, the last time I recall a bail out here it was John Howard’s brothers company, and I’m sure Howard would have preferred secrecy after the fact as well.
Soros says that there is a lot more to come yet, he could see this train coming and adjusted his investments accordingly. So maybe, painful as it would be, the market should be left to make its own adjustments.
None of it says much for the highly paid execs and the supposedly savvy regulators.

lindsaylobe said...

Dynamic provisioning by financial institutions (anticipating bad debts and failures in the future based upon both past experiences combined with realistic hard nosed forecast scenarios) would have provided for most of the fallout from both the sub prime losses, associated failures and house price diminution by now.

I agree with you that you would think the regulators would have been calling on those involved and through industry channels of representation helped them come clean and to grips with the situation.

Notwithstanding it needs also to be acknowledged being wise after the event or hindsight also comes to mind and the fall in houses prices has been far more severe than many would have anticipated.

There are also hundreds of billions of these securities issued By Fannie and Freddie which are held overseas, as the contagion spreads.

But it appears to me the financial executives have been either unwilling or incapable (or maybe a mixture of both) of coming to grips with these dire likely worst case outcomes.

Here is quote from Warren Buffet from Berkshire Hathaway’s last recent Annual report which although slightly out of date I think sums it up pretty well,

You may recall a 2003 Silicon Valley bumper sticker that implored, “Please, God, Just One MoreBubble.”
Unfortunately, this wish was promptly granted, as just about all Americans came to believe that House prices would forever rise. That conviction made a borrower’s income and cash equity seem unimportant to lenders, who shoveled out money, confident that HPA – house price appreciation – would cure all problems.
Today, our country is experiencing widespread pain because of that erroneous belief. As house prices fall, a huge amount of financial folly is being exposed. You only learn who has been swimming naked when the tide goes out – and what we are witnessing at some of our largest financial institutions is an ugly sight.

PS ~Inflation and further headwinds ~ in so far as inflation is concerned the sighs are rather ominous. I noticed to day Dow Chemical Co, one of the largest chemical makers is to raise prices by 25 percent in July due to or surging energy costs.

Best wishes

Cart said...

Lindsay, without question I accept your argument; your logic on these issues continues to be unerring.
My issue is how to get complex messages through to a relatively uninformed base.
I doubt we have even begun to break the confusion between markets and the economy. To make it worse, we are now reflecting on the market effect on the economy that is unrecognised.
I admit I come at it as the old campaigner with a limited economic grasp, so I really appreciate your focus.
The big concern really must be that if the US keeps down its current path the rest of us will be sucked into the resulting black hole.

DivaJood said...

Foreclosures, new condo conversions being sold at auction - it is a serious mess. Because I am not an economist, and because I am actually struggling with my mortgage and with falling prices, I feel this problem first hand.

Several friends of mine have been talking about all selling our homes and buying something together, and creating our own commune. Why not? It could work for us.

Cart said...

Diva, it might come down to creative personal responses. At least, (and meaning it kindly :) you witnessed the way it works first time around.
I did too, and communal living is too ugly for me to contemplate.

DivaJood said...

Ah, Cart, I'm proud of my wrinkles. Not so much the grey hair, but the wrinkles.

And at this point, having lived alone for 17 years, communal living is less appealing. I've done it, both as a hippie and as a "pioneer" in Israel. It requires compromise that I don't always want to make.

Cart said...

Diva we occasionally, elsewhere, reflect on people of the thespian persuasion. I have to say here and in the US I get a real thrill seeing the greats (and just contemporaries generally) growing older graciously.
A wrinkle or even graying gives me an odd sense of comfort. I saw an interview Meryl Streep recently and was in awe that she was still the same Streep only older.
But even younger I could never contemplate the idea of the commune.