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Mike hopes to see the world turned upside down through local communities banding together for social change, especially churches which have recognized the radical calling to be good news to the poor, to set free the prisoners and oppressed, and to become the social embodiment of the reign of God on earth as it is in heaven. He lives with the blessed memory of his wife, in Durham, NC, and has three adult children living in three different states. He also shares his life with the Mt. Level Missionary Baptist Church in Durham, the faculty and students of Shaw University Divinity School in Raleigh, NC, and the faithful fans of Duke and Baylor Basketball in his neighborhood.

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Monday, September 29, 2008

Bailout 2: Bailout or Feeding Frenzy?

Bailout or feeding frenzy?

The failure to pass today's bill promising a solution to the credit crisis should not be a big surprise. Numerous members of Congress were reporting contacts from constituents opposing the Bush/Paulson plan at ratios between 100/1 and 1000/1. This weekend's Citigroup acquisition of Wachovia Bank should give us a clue into the anger and opposition of the populace. Citigroup swooped in and acquired an enormous range of financial resources at fire sale prices. This is exactly the kind of profiteering, even racketeering, that the average person suspects is going to happen.

Citigroup, it is said, has tried without success to build a consumer banking business for many years. Raking in money in other ways, they were among the financial institutions not overwhelmed by the mortgage crisis. (What happens when this morphs into a consumer credit card debt crisis, is yet to be seen.) Bad decisions by First Union, which renamed itself Wachovia when it acquired the previously well-managed bank, included buying the mortgage company which specialized in one of the now-despised mortage innovations, option adjustible-rate mortgages. These are the ones that let the borrower take the option of not making a payment now and then (and adding it on the end of the loan period). Now they own too many bad mortgages.

The strange thing about this crisis of "securitized" mortgages is that they are really worth much more than the market is saying. Around 2.5% of mortgages are in foreclosure. Many of those have been processed into interest-bearing securities, or bonds. So on average, it might be that the value of such a bond, in real terms of how much it would pay out, may have dropped to around 97.5 cents on a dollar. But let's estimate that the mortgage bonds are worse off than that because they are encumbered by additional mortgages which are not yet in foreclosure, but in danger. And let's say that these securitized mortgages have a larger share of the bad mortgages from the recent frenzy of bad financing than the 2.5% rate would indicate. So maybe these interest-bearing bonds may pay out 90 to 95% of their face value. Maybe a few would be even lower, or much lower. But that would not cause such a crash. What causes the crash is that since no one wants to buy these securities, their price drops way below their adjusted value. Then the holders may find themselves with a cash-flow problem. They need to sell some securities, but they can't get a buyer at a fair price. When this infects the whole market, the financial institutions start to treat these securities as if they are worth almost nothing. As a side effect, a powerful and wealthy institution like Wachovia finds its stock dropping to pennies. But buying them at a low price is a great idea if you don't have to worry about cash flow. The government has time to see them pay off, and maybe at a good profit.

In walks Citigroup, with the help of the FDIC, to pay a measly $1 per share to buy one of the largest banks in the world with assets galore. Buying at a fire sale lets them reap a huge reward. Just like Bank of America bought Countrywide and Merrill Lynch. Just like J. P. Morgan Chase bought Washington Mutual. After all this hoop and holler about a financial crisis, the US is left with three financial giants who have an even greater ability to dominate the financial business and exercise a joint monopoly over setting interest rates and fees.

This so-called bailout had nothing to say about the concentrated power of wealth in the hands of the few. And its fatal flaw was that it did nothing to help the other people caught in the mess of bad mortgages. The bailout plan had no provisions to help refinance mortgages for common people, homeowners who are facing foreclosure in a weak economy. It was suggested that by buying these mortgage-based securities, the government would be able to refinance mortgages for homeowners. But owning the security is not the same as owning the actual mortgage. These remain in the hands of banks, savings and loans, and other mortgage institutions all over the place. This plan does not offer any relief to them. It offers relief to large financial instutitions who have questionable securities.

So an additional provision to assist homeowners might have been enough to win a few more votes. The provision to deny "golden parachutes" are a gesture toward the common borrower, but not much more than that. Real help to homeowners is what was needed. The long and heated meetings about bailing out the economy could not muster the compassion and courage to do what was right. The proposal allows the same feeding frenzy to go on. As one commentator said today (I can't remember who), the homeowners who endure foreclosure faces the greatest crisis. They can't go back to their neighborhoods. They lose the bedrooms and kitchens where they lived. They no longer live where their ball teams or other social connections had been built up.

The Neighborhood Assistance Corporation of America released the following comments:

There is one reason for the financial crisis – Foreclosures.
There is only one solution – Restructure mortgages to make them affordable.
Who would benefit – Everyone.

This seems to me to sum up the shortcomings of the proposed bailout.

Thanks to reports on NPR's Morning Addition, AP news reporting by Sara Lepro, and the insights of my friend Steve Bumgardner for helping me think abou this issue. Any erroneous reporting and reasoning is mine.

1 comment:

Ryon said...

Mike -

I have really appreciated these posts.

You are right that what we have witnessed in the past few weeks is a consolidation of wealth of unprecedented magnitude. The only thing that could top this would be for Clear Channel to have made the announcement. Or perhaps Buffett himself could deliver the news.

You are doing real work here on this blog. Keep asking these questions. These are the questions my congregation is asking at the dinner table; unfortunately most of us feel too unqualified to raise these questions in the public square.

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