Posts Tagged ‘bail out’

Where is Paulson going to get $700 billion for his bail-out plan from?

Sunday, September 28th, 2008

There’s news of a (yet another) tentative deal for Henry Paulson’s US$700 billion bailout Plan. There is a lot of public discontent and anger over the plan. After all, why should Main Street pay for Wall Street’s stupidity and greed? What about the millions of dollars of ‘golden parachutes’ for executives? The idea of the Plan sounds good in principle, but there are a lot of unanswered questions.

First, as Congressman Ron Paul grilled Ben Bernanke, if the free market has no idea how much these dodgy assets are worth, then how on earth can the Treasury and the Fed work out their value? Ben Bernanke gave a very unconvincing answer. As we explained in How much to pay for toxic debt?, if the government is too stingy in the price it pays (so as to act in the interests of tax-payers), then the Plan will become completely pointless. It’s an either all or never situation. Half-baked measures are worse then no measures.

This leads to another question. Even if it’s possible for the authorities to work out how much these toxic stuffs are worth in due time, where on earth did they come up with the figure of $700 billion? As this article reported,

“It’s not based on any particular data point,” a Treasury spokeswoman told Tuesday. “We just wanted to choose a really large number.”

In other words, that figure was just a ‘large’ number plucked from the sky.

Next, is that ‘large’ figure, $700 billion enough? We are doubtful. Total private debt in the US is a cool $41 trillion and that does not include the many trillions of dollars of public debt. Estimates of the US public debt that includes the unfunded medicare and social security liabilities ranges between $40 to $55 trillion (see How is the US going to repay its national debt?). Therefore, $700 billion is really chicken feed. Marc Faber estimated that $5 trillion is a more realistic figure.

Then, the next question to ask is this: where on earth is the money going to come from? If the US government issues new government debt, this will increase the debt-servicing burden of the US government, which in turn means that the tax burden of the American people will have to increase. But after listening to yesterday’s McCain-Obama debate, we couldn’t believe our ears when both of them were talking about tax cuts! With a national debt so astronomically high, nationalisations, bailouts and the Plan will increase it even further. How on earth could these two presidential hopefuls talk about cutting tax?

Regardless of the wrangling due to the Plan, this fundamental fact remains: the entire nation has no means to pay for its public and private debt. It’s either debt default or crushing tax for their current and future generations. If both outcomes are out of the question, then there’s only one way left. As we said before in Bush?s mortgage relief plan- who pays? back in December last year,

Bush could tax the American people to pay for his plan. But this will be politically impossible because in a democracy, the mob always want something for nothing. The next best alternative will be through stealth tax- ?printing? of money (see How to secretly rob the people with monetary inflation?). This way, the American people will pay through price inflation. That is, they will pay through the further loss of their dollar?s purchasing power.

Do you think the US will eventually resort to the monetary printing press?

How much to pay for toxic debt?

Monday, September 22nd, 2008

Now that Henry Paulson has already announced of a plan to bail out the US financial system with a US$700 billion (to $1 trillion) slush fund, the next devil is the detail. In this plan, the US government will buy up unwanted toxic debts from financial institutions and then sell them to the market quietly in a few years time. Because these toxic debts are unwanted, no one wants to buy them and hence, their value are priced laughingly low. As a result, the solvency of these financial institutions are threatened.

The first problem is, how much should the US government pay for these toxic debts?

First, let’s refer to the hypothetically simplified bank balance sheet in our earlier article, Effect of write-down on bank balance sheet. As you can see from that article, depending on how highly leverage the bank is, even a small write-down means that it has to either raise that amount in the equity market or sell a lot of its remaining assets to keep itself within the right side of banking regulations.

What if the the government pays a price that is better than laughingly low but still quite a distance from the book value? Banks will still have to write down the value of its asset. Then it has to raise money to patch up that hole. Given that the credit market is quite frozen up, this is quite unlikely. Therefore, its only other choice will be to sell its other surviving assets.

What if other banks are in the same predicament? Then there will be mass selling in the markets, which will then depress prices of assets even further, which then… it’s depressing to repeat the vicious cycle here.

The basic idea is that banks will still fail anyway if the US government is not generous enough in opening its wallet to pay for junk assets. Our feeling is that $700 billion may turn out to be too conservative an estimate. The government may end up spending more money than it intends to.

What should the RBA do?

Monday, June 23rd, 2008

Yesterday, our article What is a crack-up boom?, resulted in many interesting responses and questions from our readers. Each of these questions requires very long and thoughtful response. Therefore, we will slowly answer each question chronologically one at a time. If we have not answered all your questions today, please be assured that we will do so in the days to come. The answers come in a first-come-first serve basis.

Today’s article will answer this question:

Do you think that the RBA is doing the right thing then? It has raised interest rates, although it has also bailed out financial institutions.

Let’s start off with what we would do if we were the RBA (and the Federal Reserve). Not only would we raise interest rates, we would have done so very early to prick the emerging asset price bubble right at the start. So, why didn’t the RBA do that? As Ian Macfarlane, the former head of the RBA, said here,

Many people have pointed out that it is difficult to identify a bubble in its early stages, and this is true. But even if we can identify an emerging bubble, it may still be extremely difficult for a central bank to act against it, for two reasons.

First, monetary policy is a very blunt instrument. When interest rates are raised to address an asset price boom in one sector, for example, house prices, the whole economy is affected. If confidence is especially high in the booming sector, it may at first not be much affected by the higher interest rates, but the rest of the economy may be.

Second, there is a bigger issue which concerns the mandate that central banks have been given. There is now widespread acceptance that central banks have been delegated the task of preventing a resurgence of inflation, but nowhere to my knowledge have they been delegated the task of preventing large rises in asset prices which many people would view as rises in the keeping of his wealth. Thus if they were to take on this additional role, they would face a formidable task in convincing the public of the need.

The last sentence is where the problem lies. The masses have not given the RBA the mandate to spoil the asset price inflation party. Although, Ian Macfarlane acknowledged that asset price bubbles can be very dangerous for the economy, his hands were tied. Elsewhere, Coalition opposition politicians were toeing the populist line by demanding that Glen Stevens (the current head of the RBA) be grilled more frequently in order to pressure him against hiking interest rates.

The next question is: should the RBA raise interest rates aggressively now? University of Western Sydney Professor Steve Keen reckoned that it is too late to do so now. His reasoning is because at this point in time, deflation is the greater danger and that inflation, though also an evil, should be left alone for now. We believe his view is that when debt deflation takes hold, it will drag consumer price inflation along with it. Is he right? Well, we are right now experiencing asset price deflation plus commodity price inflation. If the RBA leave inflation alone, our fear is that the seeds of the crack up boom can eventually grow up to become a hyperinflation dragon.

Next, should the RBA bail out financial institutions? So far, they have not officially bail out one yet in the same way the Federal Reserve had bailed out Bear Stearns. But it has certainly absorbed some of the bad debt assets and provided more liquidity. Our view is best summed up by what Jimmy Rogers said in Jimmy Rogers: ?Abolish the Fed?,

If xyz needs to go bankrupt, let them go bankrupt. I promise you, that will send a very straight signal and you will have a lot of self-regulation when these guys start to go bankrupt.