The new capital of America’s financial system is not Washington, D.C. It’s Beijing.
The financial press will report that the big story this weekend is that the Republicans and Democrats finally agreed on the details of a bailout deal to “save” the economy from imminent collapse. But that is not the story at all. In fact, it’s pretty nauseating to see the self- congratulatory smiles on the Senators and Congressmen and women who are on board with the Paulson plan. What have these morons wrought?
Well, on the face of it, the bailout deal is pretty much the program Henry Paulson asked for, with a few bells and whistles to make everyone else happy. It gives him some discretion to negotiate warrants on behalf of the U.S. taxpayer. That gives the taxpayers potential equity in financial firms. Just what we needed.
One interesting rider to the legislation is that it gives the Securities and Exchange Commission the discretion to suspend mark-to-market accounting rules. That could come in handy. If firms don’t have to mark troubled assets to market for awhile, they can hang on to them and hope for things to improve. It’s also possible that the suspension of the mark-to-market accounting standards is just the cover Team Paulson needs to buy the assets at the non-market (much higher) price.
Don’t forget what this bailout deal is all about: recapitalising the banks. You can’t do that if you pay them twenty cents on the dollar. The politicians will call it many other things. But you can imagine that behind closed doors the choice was pretty clear. Let the banks get dragged into insolvency or borrow from abroad to recapitalise them.
It amounts to both a wealth transfer and a power transfer. The national penalty for wasting all that capital on a fraudulent housing boom is America’s increased dependence on foreign borrowers. The remaining financial institutions not forced out of business have had to partner up with non-U.S. investors, who will now own a piece of future U.S. financial earnings.
Let’s not get ahead of ourselves either. When a company goes public, it has to stage a road-show and sell itself to investors. Congress may agree to the concept of borrowing US$700 billion for its nifty bailout deal. But now Hank Paulson has to go out and actually raise that money. And who do you think he will be asking? That’s right…China, Japan, Saudi Arabia etc.
There’s no guarantee the money will be forthcoming. If it can’t be raised abroad (which gives non-U.S. investors a call on future U.S. tax revenues via interest), then the Fed will have to create new money for it. Either way, the people in Washington should realise they are selling their nation into indebted-servitude. But then, they’ve been doing it for years.
Share markets will probably rally on the news of the bailout deal. And it does seem to close out at least one chapter of the credit crisis. Other things will have to happen, of course. Banks will have to lend. Spreads between inter-bank lending rates and the Fed target rate will have to come down. And the markets must dodge further disaster from the Alt-A mortgage sector and, ye gads, commercial real estate. But how much the banks stand to lose from those developments is not on anyone’s radar yet.
What’s happening here in Australia? Well, the share market will probably get some relief this week. Are there any buyers out there? We’ll find out soon enough.
But now there are rumblings about the Aussie housing market. “Sydney house prices could fall by as much as 30 per cent in the next two years,” reports News.com.au “Morgan Stanley chief equity strategist Gerard Minack said prices could fall by as much as 25-30 per cent in the next two or three years if Australia fell into recession, and by 10 per cent or more if we have a soft economic landing.”
Ouch. And it’s not just Minack. “The International Monetary Fund recently said Australian property was among the most overvalued in the world. It said at least 25 per cent of the increase in value over the past decade could not be justified, leaving the market ripe for a correction.”
A bear market in shares and a bear market in property at the same time? That is not the sort of thing to boost consumer confidence or spending. And with business spending falling off a cliff due to the credit crunch, who does that leave to carry the spending burden?
Well, it could be that the economy doesn’t need more spending right now. Perhaps it needs more investing. But the Prime Minister is having none of it. The Daily Telegraph reports that Kevin Rudd has already outlined quite a few “nation building” projects to be financed from the $20 billion “Building Australia” fund.
Australia paid off its government debt in 2006. But maybe Rudd feels left out from the great government debt binges in the U.K. and U.S. For twelve years, the Australian government has been a net creditor, with surpluses exceeding government borrowing. It now appears prepared to borrow again.
You can have an interesting economic argument about whether government should borrow to build national infrastructure assets. But it’s no wonder people are so comfortable and used to being in debt. It’s a way of life in the Western world.
It wasn’t just Wall Street greed that led to the crisis. That is what the politicians want everyone to believe as they draft a. But the very same Washington politicians encouraged Fannie Mae and Freddie Mac to extend the dream of homeownership to as many people as possible, regardless of whether they could afford it. And when warned by regulators that the Government Sponsored Enterprises posed a risk to the financial system, Congress hid behind the idea of home ownership.
Now they want to blame it all on the lenders. There is plenty of blame to go around, although no one seems willing to accept any. Instead, we want to pretend that borrowing doesn’t have consequences and that wasted money can be instantly replenished with the bailout deal. It’s juvenile thinking.
Perhaps that is why the American government is now in the position of asking for allowance money from China the way a 15-year old asks for extra money on the weekend. Let’s hope China says yes. Maybe they’ll extend our curfew too.
Markets and Money