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The Fed Throws The Hail Mary

By: Steve Johnson

9/22/2008 - 16 Comments

The government has been trying to stabilize the financial markets for over one year, starting in August 2007 when the fed started lowering interest rates.

Things seems to be holding together for the most part, up until last week when the market came unglued as several major financial firms became very close to complete failure, which caused the Fed to step in an bail them out.  The first bailout was Bear Stearns a few months ago just before they were forced into bankruptcy.  Then Fannie Mae, Freddie Mac and finally the insurance giant AIG, while the Fed let Lehman Brothers filed for bankruptcy and Merrill Lynch sold to Bank of America. Many more are on the edge.

The stock market shot up and down 400+ points several time last week as many financial managers got more and more nervous.  The financial markets around the world followed with wild swings that left many of the emerging markets significantly down for the year.  Russia even stopped trading for a few days and the US blocked 700+ financial firms from short selling their stocks. 

As the clock ticked down towards the end of the week, if became apparent that the problem was growing faster then the Fed would react on a daily basic.  What if Henry Paulson were to take a day off?  The clock ticked down to 13 seconds left in the fourth quarter. With no timeouts left, the Fed’s coach sent in the play – the Hail Mary.

The Hail Mary

The Hail Mary is to give Treasure Secretary Henry Paulson dictatorial power unreviewable by the third branch of government, the courts, to try to resolve the crisis with congress approval to buy $700 billion in bad mortgage investments from financial companies – so they can be repackages and resold at a reasonable price – while averting a credit freeze that would bring the world’s largest economy (and very possibly the global economy) to a standstill.

The dictatorial power would prevent anyone from using the courts to take action against the operation. The operation would have complete control to buy or sell any company or assets of any company that it felt necessary, without that company having any legal authority to refute. (I just hope the wrong guy doesn't get into this position)

Treasure Secretary Henry Paulson speaking on NBC's Meet the Press said: ``This is not a position where I like to see the taxpayer, but it is far better than the alternative.'' The proposal would raise the nation's debt ceiling to $11.315 trillion from $10.615 trillion and require the Treasury secretary to report back to Congress three months after Treasury first uses its new powers, and then semiannually after that.

Precedent Bush, who has always been a free market guy, had this to say; ``I'm sure there are some of my friends out there that are saying, `I thought this guy was a market guy, what happened to him?''' the president said. ``My first instinct was to let the market work, until I realized, while being briefed by the experts, how significant this problem became.''

The Taxpayers Obligation

$700 billion / 300 million people = $2,333 per person.  That’s about $10,000 per family.

Add this to the 9 trillion from the current national debt and each family owns about $100,000.

The plan is to give the banks their much needed cash in exchange for these bad mortgages, so the banks can continue to operate.  Then, after the crisis is averted and the markets stabilize, the bad mortgages will be packages up and sold so that the government can get back at least some of the money they give the banks for them. 

What I don’t understand is if most of these bad loans are defaulting because the people cannot repay them, then how are they ever going to be worth anything?  And if most of the loans were sold to foreign banks, then why would they want to buy them pack?  If you think about it, we are giving the foreign banks their money back for these bad loans that we sold them and then we are repackaging the same loans and trying to sell them to the same people.  There is no way foreign banks are going to purchase these loans again. 

It’s highly unlikely that we are going to be able to recover much of the money.  The alternative is to let the banks go under and tell all the foreign banks that their money is gone – so sorry.  But, we cannot do that because we have a negative trade deficit. We borrow almost $2 billion dollar a day from the rest of the world just to operate our nation.  If we screw foreign banks, they will stop buying our Treasury Bonds, which we use to run our nation.  Worse yet, they could start selling them and the value of the dollar would sink.  We are definitely in a difficult situation, leaving Henry Paulson, Ben Bernanke, congress and the President with no other option but to throw the Hail Mary.

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