Upsides of the bailout for FIREes

[free4now]

There's plenty of bad news to go around, so I am starting a thread for the good news on this bailout.

I see several ways that this bailout situation is better for FIREd people like myself than for other people:

• Since I have a big portfolio and relatively small taxes, I'm much more exposed to the stock market than taxes. Lets say the bailout ends up being net 1 trillion dollars spent. That is about 2% of the US stock market capitalization, which is approx 50 trillion. So if the Guv pumps that much into the stock market it will necessarily increase the overall market by at least 2%, and of course the intention is that it will stave off a much greater decline. Two percent of a million dollar portfolio is $20k. Whether it's 2% or 10% or 50% that my portfolio is up from the bailout, it's a good thing for me. Now to calculate my tax liability... Lets assume that my income taxes are the same as that of the average US citizen, to make the calculations easy. 1 trillion divided by the US population of 300 million is approximately $3k, the present value of my share of the tax burden. Since I'm getting $20k or more in portfolio increase, at a cost of only $3k in taxes, this bailout is a very good thing for me, no matter whether it's successful or not. Of course people like ourselves with big portfolios and low taxes are rare, and most of the US population will end up worse off, but hey, I've got mine
• Just like 9/11 changed our country's approach to security, this bailout will change the country's approach to financial transparency and market regulation. In the end the markets will be more transparent and so should tend to track intrinsic value straighter and with less volatility, which helps us folks who are living off our portfolios.
• With the hangover of this credit crisis, and the new regulations adding friction, credit is likely to be scarce for a long time. This means that our big portfolios of freely investable funds will be relatively more valuable to others.

 

[2B]

I tend to think this is the greatest government confiscation of property in the history of the world. The number of non-performing mortgages is small relative to the number of performing mortgages. The current squeeze is a combination of unknown credit factors inside companies that were repeatedly attacked by naked short sellers. As their prices fell the rating agencies dutifully assumed that the rumors must be true and the downgraded the companies. The naked shorts attacked again triggering clauses that required infusions of capital or the company defaults on massive amounts of debt that would bankrupt them. Once they got the first bankruptcy, they were off to the races again because the panic selling forced the mark to market rule of the liquidating performing assets valued at junk prices. This weakened the otherwise solid companies and the cycle continues. As long as mark to market and naked shorting continued the entire financial system was going to collapse.

Now the government stands ready to take these otherwise performing assets off a company's hands at a bargain price. The naked shorts are turned off (hopefully) and the government has no need to mark to market. They can keep receiving your mortgage payment for as long as it takes to recover the original principle. They make big profits on most of the paper they will take over. They certainly won't take over non-performing paper for more than the true net asset value of the underlying collateral. Even here, they won't need to take on much.

Eventually, sanity will be restored and maybe the government will not continue to be in the private equity business for very long. Now if only our congress can keep from trying to make this a grand experiment in social engineering......

The fools that bought all sorts of bad CDOs won't be so lucky. Much of the worst paper was marketed to individual investors. That stuff is non-performing. The government has no intention of bailing out individual investors that bought bad paper. Too bad if you did.

 

[clifp]

Excellent analysis Free4Now. I think anybody with a $1 million or more of liquid assets, while not exactly a Wall St Fat cat is at least a well fed cat.

The dropping of millions of tons of cheese into the system is going to keep a bunch of rats which should have starved healthy. So even if we don't eat any of the cheese, we still benefit by a having plumper rats to catch

 

[Finance Dave]

"So if the Guv pumps that much into the stock market it will necessarily increase the overall market by at least 2%"

that's an assumption I'm not willing to make. If investor confidence falls, the market could go down further. Kind of irrational exuberance in reverse.

 

[nepo]

This analysis is simplistic and wrong. The Guv is not pumping any money into the equity markets. It's borrowing at a minimum $700 billion dollars to buy bad assets from a few financial institutions. There's not guarantee that what the government buys will go up in price as the housing decline continues and there's no end in sight. Second, if the Guv is really helping those financial institutions it will have to do it by buying at a premium price so there's even less chance of the Guv making any money on the bailout.

The borrowed money will have to be paid out with interest to those who lend, probably China, Japan and certain countries in the Middle East. The US Taxpayer, no matter what tax rate they are in, will have to pay for this, so higher taxes are unavoidable, and that tax increase can be substantial. This will drive the value of the dollar lower and high inflation will follow.

Any gains in the stock markets (which are quite speculative in this environment) will be more than offset by the declining dollar and the higher inflation. The more China and Japan and the ME lends us, the more vulnerable we are to the political whims of those countries. China in particular wants the US to ease restrictions on their Guv buying US assets like companies, industries, infrastructure, etc. If that is not happening, China will get ready to eventually dump their massive dollar holdings.

The US Taxpayer loses, making this potentially the biggest transfer of wealth in a single event from the US Taxpayer to the few financial institutions that may benefit.

 

[samclem]

Hey, this is supposed to be a happy thread!

Happy: I agree that interest rates are almost surely going to rise, and that could help those of us with liquid assets who want to put it into bonds/CDs, etc. It's not just the Chinese who stand to benefit.

Not Happy: Unfortunately, inflation is also likely to increase. And, it's no good getting 6% on your bonds if inflation is 7%.

Not Happy: I'm not sure I agree with the assumption that the average ER or R will have low taxes. The people who are producing earned income will not singlehandedly shoulder the tremendous tax burden that is coming (a burden caused by our military expenditures, by this current huge bailout, by our unfunded Medicare and SS liabilities, and by the many promised new social programs that some politicians and the electorate seem to want). We're surely going to see increased taxes on cap gains, and we'll probably see means testing of SS. I would not be surprised to see a wealth tax (a more direct one than the Cap Gains tax is) and a higher tax rate on interest thanon earned income. We are the rich and we will be soaked.

 

[free4now]

This analysis is simplistic and wrong. The Guv is not pumping any money into the equity markets.

It is certainly a simplistic analysis and the numbers are debatable, but the point I think holds no matter what the numbers are: The bigger your equity position and the lower your taxes, the better a bailout is for you. And conversely people with low equity positions and normal to high taxes will be worse off.

The borrowed money will have to be paid out with interest to those who lend, probably China, Japan and certain countries in the Middle East.

Good point. If we spend most of it in foreign markets then my argument falls to pieces. I am guessing in the end most of the spending will be in the US, just because it's less politically dangerous for Paulson and our government. I don't think we have enough time to do anything but the most expedient thing, which is spending most of it in the USA, even though spending overseas would make sense given that this is a global problem.

 

[riskadverse]

...Not Happy: Unfortunately, inflation is also likely to increase. And, it's no good getting 6% on your bonds if inflation is 7%...

While this may be "not happy", it may be an astute investment in the current environment.

 

[socca]

Inflation is the #1 threat to my future financial well-being. I'm not certain that a vast new welfare program for Wall Street is necessarily inflationary. There are many factors to consider, and inflation is partly a psychological as well as a financial issue, which makes it even trickier to analyze. I'd like to have a better grip on this issue.

 

[free4now]

If the Fed really pulls this off right, they will have done exactly what Warren Buffet does, buying distressed assets at a discount because he's the only one with the liquidity and speed to get such a deal done. Maybe Paulson is the secret successor to Buffet?

 

[deserat]

samclem - I agree with you on your analysis regarding the increase in taxation against all types of assets - interest bearing, dividend bearing , property owning and earned....also, means testing for any government 'subsidy' to one's income. And lest anyone say we should have a consumption tax...we do - it's called sales tax.

 

[socca]

...buying distressed assets at a discount...

That's what the administration would like us to believe, and it's a seductive mental model. Unfortunately, it's wrong. We won't be buying assets, we'll be buying risk. Do you think that Paulson will be out on the weekends cutting the grass around the newly foreclosed homes the Federal gov't will now own and try to sell?

The risks that we will be buying will be of two types:
1) the risk associated with the security is unknown due to the complexity of the instrument; or
2) the risk is known, and it's not a risk that any prudent investor would ever want to take. That's where you and I come in - we have deep pockets and profound stupidity.

If this bailout goes through in anything like its originally proposed form, we may as well change the name of this great nation to G.S.A. : Goldman Sachs of America.

 

[joesxm3]

If 9/11 changed our security outlook, how about putting the people who caused the problems in g'tmo for a while?

 

[cute fuzzy bunny]

It'd be a lot cheaper and more efficient to just put a uniform on them and stick them on a C-5 headed east.

 

[socca]

The risks that we will be buying will be of two types:
1) the risk associated with the security is unknown due to the complexity of the instrument; or
2) the risk is known, and it's not a risk that any prudent investor would ever want to take. That's where you and I come in - we have deep pockets and profound stupidity.

Here's is Bill Gross's counter-argument to my argument:

washingtonpost.com

There are a couple of things missing from Bill's article:
+ if these securities are such a great deal, then why do we taxpayers need to step in and buy them? There is plenty of capital sitting on the sidelines waiting for a good investment opportunity, as Buffett's investment in Goldman Sachs illustrates.
+ the last 5 years have seen an unprecedented war-profiteering feeding frenzy among Iraq war contractors. There will be a similar feeding frenzy among bad-debt profiteering financial services contractors if the bailout is approved. When Bill mentions companies capable of helping the government evaluate bad debt, he's thinking first and foremost of his own company - PIMCO. PIMCO stands to make a fortune as a bad-debt disposal contractor. Bill really should have disclosed this conflict of interest as he promotes passage of a Wall Street bailout ASAP.

 

[tomintucson]

I'm unable to muster any predictions of likely outcomes from the bailout. Events of recent months are truly cataclysmic. All bets are off. One thing I can be sure of is that many of the consequences of our government's intervention will be unintended. Peril or profit from this point onwards? Beats me.

Tom

 

[2B]

Here's is Bill Gross's counter-argument to my argument:

washingtonpost.com

There are a couple of things missing from Bill's article:
+ if these securities are such a great deal, then why do we taxpayers need to step in and buy them? There is plenty of capital sitting on the sidelines waiting for a good investment opportunity, as Buffett's investment in Goldman Sachs illustrates.
+ the last 5 years have seen an unprecedented war-profiteering feeding frenzy among Iraq war contractors. There will be a similar feeding frenzy among bad-debt profiteering financial services contractors if the bailout is approved. When Bill mentions companies capable of helping the government evaluate bad debt, he's thinking first and foremost of his own company - PIMCO. PIMCO stands to make a fortune as a bad-debt disposal contractor. Bill really should have disclosed this conflict of interest as he promotes passage of a Wall Street bailout ASAP.

The problem with any private entity is that they don't know how low they will go. Public firms will be hit with "mark to market" which may destroy the entire value of any financial asset whether it's performing or not based on what's been happening. Private companies are waiting to see what will happen. Most are already well stocked with these assets and before they buy much more at 45 cents on the dollar they want to see if they will go to 10. Yes, eventually the private equity people will clean up the mess but credit as we know it will disappear for the foreseeable future. The FDIC will take over half the banks and many public firms will fail. Welcome to the real Great Depression.

PIMCO al la Bill Gross has actually fed the problem with his "great insights" on CNBC et al. He was buying this debt but now he's suddenly realized his funds may go down the toilet with everyone else. When cash is king, his stinkin' bond fund stinks.

If I was Bernacke, I'd give a great resignation speech and say congress can decide whether the economy should collapse or make a big profit for the taxpayers by extorting performing assets from terrified financial companies.

 

[youbet]

If I was Bernacke, I'd give a great resignation speech and say congress can decide whether the economy should collapse or make a big profit for the taxpayers by extorting performing assets from terrified financial companies.

Me too!

It's not like Ben needs his next paycheck from the fed govt to be able to make his mortgage payment! As I've been saying in various threads, whether it's fair or unfair and for better or for worse, the ball really is in Congress's court. The majority party can call the shots with no fear of veto. They understand their mission as it was given to them by the voters that put them in power to change things. Now, get busy, take the bull by the horns and make the necessary decisions and stand by them going forward.

 

[2B]

Me too!

It's not like Ben needs his next paycheck from the fed govt to be able to make his mortgage payment! As I've been saying in various threads, whether it's fair or unfair and for better or for worse, the ball really is in Congress's court. The majority party can call the shots with no fear of veto. They understand their mission as it was given to them by the voters that put them in power to change things. Now, get busy, take the bull by the horns and make the necessary decisions and stand by them going forward.

I've been listening to Bernanke's testimony this morning while gd-II was sleeping on my stomach. She kept me from upchucking at the political diatribes and posturing going on. Even my own congressman (Ron Paul) spoke out of both sides of his mouth wanting the markets to work, tax payers not to foot the bill and to not have anything get really bad.

I'm amazed at how well Ben keeps repeating "significant credit tightening," "continued housing deterioration" and "substantial equity erosion" without telling these buffoons to shut up with the BS and do something to help.

I've been no fan of Bernanke from his first misguided rate increase that he used to show "he would fight inflation." The Fed and Treasury have been consistently behind the curve and have not stopped anything bad from happening. The next step they have suddenly realized is a big one. They threw every brick they had at it and it isn't enough. The asset confiscation now seems like the best route forward. Now congress is worried about "Main Street not bailing out Wall Street." Many also seem to see this as a chance to cram every social engineering scheme imaginable into the bill.

Bernanke has stated the same thing I've been saying is that the "buyout" will assume assets at "fire sale" prices and they can hold them without worrying about marking to market. By providing a reasonable market for these securities, they can infuse the phantom capital that has been lost due to this silly accounting rule.

 

[cute fuzzy bunny]

Do recall that Bens main qualification leading to his appointment was that he was able to take all the tactics and things done and invent a strategy that seemed to fit them.

Usually stuff is done the other way around. You come up with a strategy and then draft tactics to implement it.

This crisis seems to be getting the same approach. Lots and lots of tactical stuff getting done, no big picture strategy or framework to either take our medicine or heal the whole.

 

[2B]

CFB,

Good insight into the lack of focused response. I tend to do the opposite and find myself not reacting as quickly or as I should or acting too quickly. My fixed asset allocation is somewhat of a response to a tendency to overreact. I'm sure I would have invested every dime I had all the way down believing "they" aren't that stupid. Wrong once again.

I truly believe this all could have easily been prevented or easily corrected all the way to this point. I also believe that this is probably our last chance without a real bloodbath. After the short selling ban expires and the "mark to market" continuing to swing over every asset, we'll be forced to let the market find its own much lower level.