MUTNODJMET'S MUSINGS

Dear Friends:

I have a dear, dear friend who is well positioned in the banking industry. I, myself, am not very knowledgeable about economics, finance, or related fields. So, when I have serious questions about these matters, I go to her for advice.

Needless to say, in the midst of all this chaos, I turned to her for some guidance. I asked her to write a synopsis of the current situation, and it is presented below. I am hoping she will grace us with a few more posts during the tumult we now face.

THE RECESSION LESSON

We are as humans destined to repeat our history, most notably those lessons we fail to learn from, or which have not impacted a present generation’s experience. We are a new society unaccustomed to saving and waiting for things we want. We are so media-driven we can’t look up from our I-Phones long enough to see there are much more serious things to look at. Like where our next paycheck is coming from.

Yesterday was a historic day for the Dow Jones Industrial Average, a historic day for commodities, and a historic day for the U.S. Bond Markets. Congress did not pass the stimulus package requested by President Bush and Treasury Secretary Paulson, crafted to purchase sub-performing loan assets and ostensibly unlock frozen credit markets. Stock indices fell 7-9% on the day in reaction, T-Bill rates collapsed to less than 1%, and repo markets were locked for the day as credit risk became germane. Perhaps most important to experts in the credit markets, overnight LIBOR jumped from 2.59% to 6.88%. These are only the reported rates, and actual rates paid by banks were no doubt higher. It could not have happened at a worse time, at quarter-end and with many of the risk “spreaders” in terms of Wall Street no longer available. Fewer participants always mean less liquidity. Allowing Lehman Bros. to fail meant no taxpayer price tag. Unless you factor in the complete disarray such action caused in terms of risk to credit markets.

While the stimulus to credit markets in form of a bill will undoubtedly be addressed again this week by Congress, and we can at least hope that it is termed differently than a “Wall Street Bail Out Bill”, with the public deluded into believing that the package will be used to pay huge Wall Street salaries and bonuses. It is time to begin the assessment of what the recent plunge in the DJIA does to individual homes and people who borrow, who have jobs, and who expect their pension check in the mail. People will quickly forget the populist rhetoric, blaming rich people and blaming Wall Street’s greed, when they realize that their pension plan is underfunded and they won’t be receiving a check now. They’ll forget about it when they lose their job in the worst recession of our lifetime. They’ll forget about hating President Bush when they can’t get a loan on a home. They’ll stop hating Wall Street and start hating their employer when their paycheck can’t happen because their company can’t make payroll. They’ll text message, e-mail, telephone, and write their Congressional representatives in droves to “fix the problem”. They’ll expect, because we’re an instant gratification culture, immediate results. They won’t be immediate, and most likely not even within the next President’s administration, no matter who he may turn out to be.

Americans share in this massive deleveraging now taking place globally. We took out the loans that are now in credit default. We need to pay off the debt we all have, inclusive of the federal government. Credit can be extended, once financial institutions know how much capital they have. We need to see Congress address the inherent illegality of Credit Derivative Swaps where there is no credit exposure, along with massive short-selling of financial institution stocks. These market manipulations are not productive toward turning the problem around, and neither is mark-to-market accounting, the FASB’s standard in recent years which means financial institutions are often forced to take massive losses on their balance sheet due to security valuations that do not reflect risk, but instead reflect broken liquidity markets. It is time to allow banks who intend to hold assets to maturity to do just that, and to assess their available capital and go back to lending without concern about an orchestrated run on their stock. These liquidity issues and bank solvency are what Chairman Bernanke and Secretary Paulson need to emphasize. It is their job and their reason for existence, and not private security markets on Wall Street.

Whether or not Americans find it palatable, there will be necessary government foreclosure of FDIC-insured institutions, and there will be ownership collectively by the taxpayers of subprime mortgage assets. We will need an agency to pool these assets and manage them by improving the structure through time and selling both the new assets and cheap liabilities. It can be done, as it has in the past, successfully. This corporation, similar in nature to the Resolution Trust Corporation formed back in the 1980’s, can eventually make money for taxpayers. Whether or not Americans find it palatable, what happens in our financial institutions involve our own individual finances and our homes. Our property valuations are impacted by our neighbor’s foreclosure sales. It’s in the end up to us to sacrifice and to assume the responsibility of worthy credit choices. It’s up to us to use the words, “We can’t afford it” to our families along with our Congress. It’s up to us to continue to make the point to government leaders that the federal government cannot spend us out of this problem even with the largest checkbook in the world. The problem isn’t spending. It’s reducing spending and beginning real investment in our futures. Don’t believe election year rhetoric that investment starts with government. It starts with us, on Main Street, with the private businesses and people who work in them that turn the engine of the economy of the United States. It is time to reform and streamline government. And it is time to reform and streamline how we do business.

Americans said “no” overwhelmingly to the requested package proposed yesterday, but restoration of liquidity into banking markets will require both time and a rebuilding of liquidity markets and credit on the institutional and individual investment sides. The question now looms on the horizon if we have the discipline for also saying “no” to massive government handouts promised in form of expanded welfare. What is good for Wall Street is good for Main Street. But it means everybody doing more with less.