The Great Depression Online

Great Depression Online Archive Issue:

Bailing Out Your Neighbor

Great Depression Online
Long Beach, CA
September 26, 2008

Inside This Issue You Will Discover…

*** Paying A Steep Premium
*** Bailing Out Your Neighbor
*** WaMu Goes Belly Up
*** And More

Paying a Steep Premium

Congress spent the week debating Paulson and Bernanke’s mega bail out proposal to rescue the financial industry from the consequences of their arrogant greed.

“It’s a terrible plan, but I haven’t heard anything better,” remarked Representative Tom Davis following a closed door meeting with Paulson and Bernanke on Wednesday.

A critical discussion point was what price the bail out fund would pay for the rotting mortgage backed securities now reeking up the global financial system.  Because banks are suspicious of the quality of the debt in these securities, its market value is at what Bernanke calls a “fire sale” price.  Yet if the bail out fund buys this soured debt at the “fire sale” price, it won’t effectively bail out the banks.

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So Paulson and Bernanke want the taxpayer to buy the securities at the much higher “hold to maturity” price.  This, they argue, will serve to bail out the banks and could be a good investment over the long term.

Bailing Out Your Neighbor

For our own benefit, we like to keep things real simple around here…

Your neighbor bought his house in 2006 – at the market peak – for $600,000.  Then, last month, he lost his job.  Now he needs to sell his house.  But because house prices have crashed, it’s now going for the “fire sale” price of $400,000.

You like the guy…and you’d hate to see him go bankrupt.  So you buy the house from him.  But you buy it not at the market price of $400,000.  You buy it at the 2006 price of $600,000.

That way you bail out your neighbor.  Plus, over the 30-year life of the loan – essentially its “hold to maturity” date – its value could go back up to $600,000 or more.  Over the long-term it could be a good investment.

And maybe Bernanke and Paulson are right.  Maybe buying the mortgage backed securities will make a good long-term investment.

But we’d rather not bail out the banks.  For we don’t even like banks…especially the Wall Street fat cat types.  We give them our deposits and they pay us a 1% return.  Then, through the miracle of fractional reserve banking, they loan out 80% of our deposits to others at 6.5% interest.  At least our neighbor offers a funny joke from time to time…or fills us in on how the Dodgers are doing. 

The way we see it, the taxpayer’s footing the bill at the steep “hold to maturity” premium, they should also get equity in the banks they bail out…just like Warren Buffett’s getting from Goldman Sachs.

“Buffett’s Berkshire Hathaway Inc. said Tuesday it was investing at least $5 billion in Goldman,” reported Tim Paradis for AP.

But unlike Paulson and Bernanke’s bailout plan, Buffett’s included more than just good will in his bailout.  Namely, he’s included his own self interest…

“Buffett is getting sweet terms on his investment in Goldman,’ reported Aaron Task for Yahoo Finance, “A 10% yield on $5 billion in preferred stock.  Warrants to buy up another $5 billion of Goldman common stock at $115, or 8% below Tuesday’s closing price.”

Shouldn’t the taxpayers get a cut of the action too?

WaMu Goes Belly Up

And last, as we were wrapping this up, we got word that WaMu’s going belly up…

“Washington Mutual Inc was closed by the U.S. government in by far the largest failure of a U.S. bank, and its banking assets were sold to JPMorgan Chase & Co for $1.9 billion,” reported Elinor Comlay and Jonathan Stempel for Yahoo News.

“The rescue marks a historic step to clean up a U.S. financial system littered with toxic mortgage debt.

“Washington Mutual, the largest U.S. savings and loan, was closed by the federal Office of Thrift Supervision, and the Federal Deposit Insurance Corp was named receiver. Customers should expect business as usual on Friday, the FDIC said.

“The bailout came after the thrift suffered deposit outflows of $16.7 billion since September 15, the OTS said.

“‘With insufficient liquidity to meet its obligations, WaMu was in an unsafe and unsound condition to transact business,’ the OTS said.”

In a world fraught with hyperbole, we consider the above observation to be a spectacular and rare specimen of understatement.


M.N. Gordon
Great Depression Online

P.S.  Our friend Bob Prechter over at Elliot Wave International has just released a must have issue of his Elliot Wave Theorist free.  If you want the truth about what’s unfolding right now in the U.S. financial markets, in Congress and at your very own bank, get your hands on a copy – posthaste.  Plus it’s free.  Learn all about this special offer here:   FREE Report - Elliot Wave Theorist.

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