Updated 10/07/08 By Shah Gilani Contributing Editor Money Morning
My sister lives in a landmark building in Coral Gables, Fla. There was a fire in one apartment in the building. After that fire was brought under control, the fire department - for some unknown reason - dropped a hose in the burned apartment, and left the water running ... for hours.
That inane maneuver destroyed many apartments, crippled the building's infrastructure and resulted in the building being temporarily condemned. The entire building was closed down for many months. Every person who lived there had to relocate. My sister, fortunately, had the wherewithal to take up temporary residence in the world-famous Biltmore Hotel.
But others weren't so lucky.
When the banking-system bailout plan - formally referred to as the "Emergency Economic Stabilization Act of 2008" - was originally unveiled, the financial-crisis firefighters at the U.S. Treasury Department were essentially reprising the Florida firefighting strategy. And U.S. taxpayers can anticipate an outcome a lot like the one that afflicted the Coral Gables apartment dwellers.
Unfortunately for the U.S. taxpayer, there's no Biltmore in which to seek temporary shelter. There's only one U.S. economy, and we have to stay in it, whether it's been condemned or not.
The Senate passed the bailout bill late Wednesday night (Oct. 1), followed by the House of Representatives Friday (Oct. 3). U.S. President George W. Bush signed the bill into law immediately after the House vote.
In plain English, here's what's wrong with the newly passed "bailout" plan and what alternatives should have been included as part of any plan that had a hope for success.
The Treasury plan was originally predicated on buying $700 billion of collateralized residential mortgage-backed securities that banks could not unload. The idea was that the banks would get the money, which they could then turn around and lend to keep the credit markets open and credit flowing throughout the economy. In the meantime, the Treasury Department would sit on the securities until it is able to sell them, hopefully at a profit. The idea, from a theoretical standpoint,isn't stupid. It is, however, impossible to implement to any degree that will result in its intended effect.
Here's why:
How are the Treasury Department and the U.S. Federal Reserve going to be able to conduct objective, responsible policy regarding fiscal matters and interest rate decisions when they will have to simultaneously "manage" the government's portfolio of securities? There will be conflicts and there will be fallout for the U.S. dollar and fallout with regard to American interests vs. the rest of the world, with whom we trade and partner with in all manner of ways, not the least of which involves our own national security.
While the idea that taxpayers should get warrants and ownership in the entities that we buy securities from is theoretically a good idea, there are some issues. Let's take a look at some of the biggest potential pitfalls:
After the House rejected the initial bill - and U.S. stock prices plummeted - the Senate rushed through its modified plan, which the House subsequently passed and the president signed. But that was just another hose from the same firefighting gang that can't shoot straight; which will further douse the prospect of a directed approach.
Here are some of the additions that were made to the plan that the House originally rejected - meaning they are part of the plan that was signed into law. Ask yourself this question: What do they do to actually address the credit crisis?
What is the common denominator to all these add-ons? They are meant to be added up so that Congress can say: "This is how much we're going spend to help fix the problem that will benefit you, not just the $700 billion going to Wall Street." Don't buy into this.
However, my very favorite proposal is the push to do entirely away with fair-value - mark-to-market - accounting. This is being pushed by none other than the American Bankers Association and - guess whom else - the Securities and Exchange Commission (SEC). That's the same SEC that presided over the demise of The Bear Stearns Cos. (now part of JP Morgan Chase & Co. (JPM)), Lehman Brothers Holdings Inc. (LEHMQ), and American International Group (AIG). It's the same SEC that eliminated the up-tick rule. And it's the same SEC that handed over to the exchanges the authority to decide who should be on the "do-not-short" list.
The truth that needs to be front-page news it that if there wasn't Fair Value, mark-to-market accounting we would never have seen this crisis coming. Doing away with mark-to-market accounting does not change the value of problem securities. Period. Doing away with mark-to-market will only bury the bodies under the rubble. The stench will eventually suffocate us all...to death.
On top of the list of solutions should be an immediate address of:
The problem right now is that we're being force-fed a political solution in the immediate glare of an election, instead of a sound economic, market-based solution to a financial crisis.
The 228 House Representatives who on Sept. 29 put aside political pressure to heroically vote against a flawed plan should have taken the lead in this firefight to offer up an alternative plan. It just so happens there was a really good one out there. The problem is that it wouldn't serve the "Masters of the Universe," the lobbyists, or the politicians who are paid off by both.
[Editor's Note: Contributing Editor R. Shah Gilani has toiled in the trading pits in Chicago, run trading desks in New York, operated as a broker/dealer and managed everything from hedge funds to currency accounts. In his just-completed three-part investigation of the U.S. credit crisis, Gilani was able to provide insider insights that no other financial writer or commentator could hope to match. He drew upon the experiences and network of contacts that he developed through the years to provide Money Morning readers with the "real story" of the credit crisis - and to propose an alternate plan of action. It's a perspective on the near-financial meltdown that more than 100,000 readers have already read - and an insight that you'll find nowhere else.
If you missed Gilani's investigative series, Part I appeared Sept. 18, Part II ran Sept. 22 and Part III was published Sept. 24. Gilani's plan was published on Sept. 25 as an open letter to U.S. Treasury Secretary Henry M. "Hank" Paulson Jr. It actually contains contact information for readers who still wish to protest the government's action with the bailout bill by passing their disenchantment along to their elected representatives in each state's governor's mansion, and in both the House and the Senate. Check out Gilani's plan of action.
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