Editorial comment

	Vol. 229 No.12
PERRY A. FISCHER, EDITOR

Fuzzy math, King Henry and the cost of ignoring root causes

Most folks think that US Treasury Secretary (a.k.a. “King”) Henry Paulson, Congress and President Bush agreed to use $700 billion of taxpayer money to bail out the Wall Street gambling parlors for making bad bets. Think again; there’s fuzzy math. There’s a sort of secret bailout that Bloomberg News recently uncovered. They are called “emergency rescue loans,” and they now top $2 trillion that the US Treasury quietly made to America’s biggest banks, investment firms and insurance companies. Taxpayers are not allowed, nor even Congress, to know who got their money, to “protect” the identity of “weak” corporations. “Trust me,” says the King.

Then there’s Section 382, a tax-code provision passed by Congress 22 years ago that makes it illegal for big banks to play a shell game that uses dummy companies to dodge taxes. Strangely, King Henry used his monarchial powers to summarily repeal this tax provision, without mentioning it to Congress, seemingly illegally. The effect is to allow big banks to take over small banks, sometimes using taxpayer bailout money, while the (suddenly legal again) tax savings cost taxpayers a guesstimated $130 billion or more. Together, these newly uncovered costs make that $700 billion look a lot more like $2.9 trillion.

So, what’s been going on these past few years, with all of these wildly gyrating prices and, now, collapse? I once heard Matt Simmons, perhaps the most outspoken and popular of all the peak oil prognosticators, answer his own question during a speech at OTC: “Why are things like oil, minerals and food getting so expensive? It’s because people realized that these things were valuable.” I bring that up only because today’s problems stem from the fact that those things were not suddenly more valuable-high prices across a broad range were bubbles-and those bubbles are bursting. That’s the root of the problem-things are overvalued.

Those $100,000 houses built in the 1980s in California were never worth $600,000. And now investors, homeowners, real estate agents and their congressmen want to believe that they’re worth at least $550,000, so that the government can pay for and write off the small difference. The reality is, they might only be worth two-thirds or even half of what they were bought for.

Besides, most of the homeowners in trouble have no money in the property: They were, in effect, only renting those 4,000-sq-ft behemoths and could not afford the upkeep on their $36,000-a-year income. After a lot of public boohooing, foreclosure might just be the best thing for them: The house next door was just bought at half price by a wealthy investor at auction, and it’s available for rent at much less than they are paying.

Sure, a few folks put money down and could afford, if only barely, the house they now live in, but have since fallen on hard times: A little federal aid could be given to those deserving folks under strict requirements. Even then, a few unscrupulous people will try to “game the system.” Odd, too, that there is so much concern about undeserving homeowners applying for federal aid, yet undeserving businesses and their lobbyists are swarming to Washington like Alaskan black flies to walrus blubber. Some are even applying to reclassify themselves as “banks,” just to qualify for bailout money. What the phrase “too big to fail” really means is too big to oppose, too big to regulate (just try it, we dare you!).

There isn’t enough money in the world to artificially prop up the value of food, real estate and commodities. Now, real buyers and real sellers-unencumbered by third-party shysters-can begin to set real prices. The best that anyone should hope for is a sharp contraction in all these bubbles, and a quick reset in prices to more normal levels. The pain simply cannot be avoided.

But there’s a problem: The market shenanigans that led to these excesses have not been changed; they’re just lying low for the moment. No one is working against the clock to establish a regulated swaps market. CFTC, the commodities regulator, has yet to say swaps against commodities must be stopped, or be subject to speculation limits, or even be transparent. A good piece of legislation that came out of the Great Depression-The Glass-Steagall Act of 1933-which prevented banks from acting like securities dealers, should never have been repealed in 1999 and should be reinstated. This was another key enabler for the subprime mortgage mess.

The rating services also must be reformed and regulated. One thing we learned from the Enron/Arthur Andersen debacle is that there is no such thing as an independent auditor when the auditor is being paid by the auditee. Moody’s and Standard & Poor’s could have prevented most of this current debacle, had they simply rated junk as junk. Maybe getting paid from an investor pool of money is the answer. In the last month or so, Moody’s alone has cut its ratings on 926 mortgage-backed securities, once worth $42 billion, from investment grade to junk status. Nothing has changed on these securities-they were always junk; they just took another, more realistic, look.

The cost of ignoring these root causes, combined with haphazard government meddling, will likely make a bad recession worse. That’s precisely what happened in the aftermath of the 1929 Crash. And let’s be honest; although getting market mechanics to work again-well-managed re-regulation-is essential, so is re-establishing faith: The unholy trinity of President Bush, King Henry and Congress does not engender confidence.

By the time the next US president takes office, the US annual deficit will be locked in at perhaps $1 trillion for 2009. And the total debt-which stood at $1 trillion in 1980 and $4.5 trillion in 2000, will likely need to have its most recent $11.3 trillion “ceiling” raised to $12 trillion or more.

Eventually, the media will start to focus on the obvious: You cannot borrow your way out of debt. With the bailout billions, together with declining tax revenues, servicing the debt will soar to more than 20 cents of every tax dollar. Considering that the large majority of the federal budget goes to military and entitlement programs, there will be pitifully little left to bring about “change.”

The hole that the US is in is so deep that Barack Obama won’t just have to be smarter than Einstein-he’ll have to walk on water as well. Despite the impossibility, he needs to start practicing.