Friday, March 28, 2008

On the tragicomedy of investment bank bailouts and distressed homeowners

From 1929 to 1933, during the time of the Great Depression, U.S. gross national product declined 29% and unemployment rate reached 25%. About 9000 banks suspended operations because of the financial distresses. In order to remedy the situation and restore consumer confidence in the banking system, The Banking Act of 1935, was introduced and a separation of bank types according to their business (commercial and investment banking) was developed. This was about the time that the Federal Deposit Insurance Company (FDIC) was created for insuring consumer deposits when a bank falls under. This means that if an individual puts their money (and faith) in a bank that is ‘FDIC’ insured, and in the event of the bank falling under, the Federal Government would step in to cover the shortfall and the consumer can ‘bank’ on the faith that s(he) will be compensated for the banks follies. In order that banks have this extra level of protection and Federal backing, they had to submit to a set of terms and conditions that included laws like minimum fractional reserves held in bank vaults as a hedge to cover shortfalls. The Federal regulatory framework also included a host of additional laws and rules that made the banks more beholden to Federal oversight (as it should - they are holding our monies). All of this extended regulatory frameworks put in place in turn cleared up the muddied reputation that the banks had developed after the Depression years…

Recently, I had written about the Bear Stearns bailout and how in my opinion, Bear should have been allowed to fail thus paving the way for a 'structural (re)adjustment' of the economy. Yes, this is bitter medicine, but much better than to live within the hype of inflated expectations and trigger happy indices that yo-yo on moment’s whim. Well, what happed was just the reverse, the Federal Reserve stepped in, bailed out Bear and helped JPMorgan orchestrate what now seems like a slapdash deal done hastily and a little bit suspiciously... A largely ignored sub-aspect of the flurry of activity that surrounded the Bear brouhaha was fine print news that the Federal Reserve also opened up its money spigots to non-commercial banks (the investment banks on Wall Street) and told them to borrow any amount that they wished from the Reserve sans oversight nor regulation. It was an open call – come by, take Federal monies, shore up your finances – all in the name of ‘preserving financial liquidity’. Recent reports state that the amount of drawing out of monies from this 'fund (called under the complex title of Term Securities Lending Facility)' is estimated to be in the region of 33 billion dollars a day over the last week and the number doubling to about 60 billion dollars a day as recent as yesterday. Can you guess the interest rate? - It was 0.33% (yes, that is correct).

Contrast this situation with news surrounding the deepening crisis that homeowners face as a result of the mortgage mess and the current state where millions of homeowners are either unable to pay their mortgages or are in danger of losing their homes because they are behind on their mortgage payments… Politicians talked about the crisis and proposed broad government rescue plans for homeowners that would each cost about $30 billion. The reply they got from the current administration was a dismissal of such ideas as bailouts and a vow (and threat) to veto even modest bills to help homeowners.

From NY1 news "All we're saying is homeowners need assistance too," said Darren Duarte of the Neighborhood Assistance Corporation. "You can't bail out the investors, bail out the Wall Street firms who created this crisis and leave homeowners at risk. We think that's not fair. And that's not the American way."

It is indeed funny and sad to see that modest bailouts for distressed homeowners screwed over by unscrupulous lenders and investment banks have little chance of success and have to go through a board legislative procedure with the attendant veto threats while broad bailouts where investment banks have easy access to over 50 billion dollars a day with little legislative oversight, zero threats of veto and little or no regulatory network passes muster with little talk or analysis… It is indeed staggering.

Georges Rouault, 1871-1958, 'Clown Tragique', 1911, oil and peinture à l'essence on paper laid down on cradled panel

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