Losses from the Bailout Vote and How to Ease Main Street's Credit Crunch

A hot populist wind blew a prairie fire into Washington today and burned up the Bush Administration's $700 billion proposal to bail out Wall Street. The President, Treasury Secretary Paulson, and Fed Chairman Bernanke wound up with major egg on their faces. So did the Democratic leadership in Congress. Wall Street was also a big loser, with expectations of a $700 billion windfall dashed.

The biggest loss, however, was of the electorate's trust in their government. Although prominent political leaders, including the two Presidential candidates, and financial experts of almost every political persuasion testified to the need for the bailout, the people just didn't buy it. Constituent calls to members of Congress ran heavily against the bailout. Americans didn't accept the idea that their hard-earned tax dollars should be used to save smart, highly-paid financiers who sometimes could hardly deign to acknowledge the existence of flyover country.

Political leaders and regulatory officials have focused on the need for confidence in the financial system. Without confidence, there is no credit, and without credit, the economy is at serious risk. They should have focused more on the need for confidence in the government, which remains the key player in propping up the world financial system. The Wall Street of the 21st Century is a black box to most Americans. Just at the level of managing one's 401(k), the financial markets are often impenetrably complex, even for well-educated and highly competent professionals. The need for a bailout of Wall Street isn't obvious--Wall Street's intertwined and interlocking layers of liabilities are difficult even for the government to grasp. It's understandable why 98% of the electorate had trouble getting the picture, and the proponents of the bailout failed to educate them properly. Too much attention was given to warning of the horrors of not bailing, and not enough was paid to explaining why all this spending was necessary. For $700 billion, the electorate deserved a better explanation than they got.

The proponents of the bailout were driven by their perceptions of the exigencies of the credit crunch to try to push the bailout package through in a week or two. They, in effect, asked the voters to trust them, the government, on the need for the bailout. The problem is that this is about their fifth trip to the plate in the financial crisis. They're 0-4 for the previous four trips. Expanded Federal Reserve lending policies, bailing out Bear Stearns, nationalizing Fannie Mae and Freddie Mac, and lending $85 billion to AIG, were failures because they did not restore financial market confidence. After all this, why would the American people again believe Paulson, Bernanke, et al.? Those guys may be right about the need for further governmental support for the financial markets, but their batting average calls into question whether they can develop the right program.

It is unclear whether the bailout proposal will be reconfigured and resubmitted for another Congressional vote. The Bush Administration has lost all its political capital, and the Democratic leadership in Congress may not want to take the lead on spending hundreds of billions of taxpayer dollars five weeks before an election. The electorate's loss of confidence in the government may be the greatest loss today, because it could preclude any possibility of a bailout package until there is a new President.

The world won't come to an immediate halt without a bailout package. The Federal Reserve and U.S. Treasury will continue to fund Wall Street, and take over distressed banks. The cost of these measures may be more or less than $700 billion. Only time will tell.

In the meantime, federal bank regulators should pay more attention to the spread of the credit crunch to Main Street, where loans are becoming harder to get. The economy outside lower Manhattan isn't vibrant, but it's still got a decent pulse. Non-financial companies are mostly operating at a decent clip and consumers are still buying, albeit not exuberantly. Small businesses may be cutting back, but the doors mostly still open every morning. Credit for many smaller businesses and individuals comes from local financial institutions, like community banks, credit unions, and savings and loans associations. Federal regulators should make sure that the funding needs of these institutions are met. The largest banks have become bottlenecks in the financial system. They will be hunkering down and operating in survival mode for a while. The federal government should use central banking facilities and regulatory policies to promote the flow of funds to the smaller institutions that can still lend to the larger economy. The voters and Congress clearly said today that they want a financial system of the people, by the people and for the people. That would be a good idea.

The Last Federal Bailout

The Bush Administration's proposed $700 billion bailout of Wall Street, if it occurs, will be the last government bailout during the current financial crisis. That doesn't mean it will work, although it may. However, the $700 billion estimated price tag, which may be low, would pretty much tap out the federal government. We're already looking at a $400 billion plus budget deficit. The $700 billion would have to be raised and spent quickly--within a year or so--in order to be of any help. Thus, the federal government would probably have to come up with $700 billion or more in cash in the next year in order to implement the bailout. The fact that the assets the government purchases may, years from now, be sold for prices higher than the government pays, is irrelevant to the government's immediate cash flow problem. Where will the federal government get an extra $700 billion or more within the next year?

Raising taxes may be in the cards for the next president, regardless of who is elected and regardless of their current campaign sloganeering. But getting an additional $700 billion could require increasing federal taxes by 50% or more. That won't happen. So most of the money will have to be borrowed. Given how the dollar and the world economy are slumping, how eager will foreign investors be to throw more money at the most profligate of borrowers in the world? Maybe, with the help of major foreign central banks (which have substantial dollar reserves and can lean on the large banks in their countries), the U.S. government can one more time scare up enough money to make ends meet. But there won't be any more loans after this one. Foreign banks are sitting on top of hundreds of billions of dollars of mortgage-related losses themselves, and are running low on capital, too. No one, not even the U.S. government, can borrow an unlimited amount of money. This will be the last federal bailout of Wall Street.

It's unclear as of tonight (Thursday, Sept. 25, 2008) whether the bailout will be enacted. Today's negotiations between Congress and the White House collapsed amidst a Republican revolt against the Bush Administration. (Conservative sentiment against the bailout runs strong.) However, the financial markets are frigid--short term U.S. Treasury bills are priced close to zero percent interest while large financial institutions can't borrow nary a nickel. There's a lot of political pressure to do a bailout, so it's more likely than not that something will be enacted by the end of this weekend.

Since this will be the last bailout, the Bush Administration and Congress had better get it right. Recent history does not inspire confidence. Within the last year, the Fed has significantly increased the types of financial firms to which it will lend, and dramatically expanded the scope of the collateral it will accept. It engineered a bailout of Bear Stearns. Next, the Treasury nationalized Fannie Mae and Freddie Mac, effectively taking over the secondary mortgage market. Then, the Fed agreed to lend AIG $85 billion in order to protect the credit default market. It's loaned many billions more to foreign central banks in order to keep credit flowing overseas. None of these measures made a difference for long. It is unclear whether the proposed big bailout will save the day. The Congressional Budget Office has noted that federal acquisition of toxic assets would set clear prices for those puppies, which could force reticent banks to own up to losses that they've quietly been keeping in closets. More financial firms could fail and things could really unravel.

If there is no bailout, or if the bailout fails, what should we expect? Short term, financial institutions will borrow very heavily from the Federal Reserve and the Treasury. No one else will fund them. At the same time, credit availability will enter a new Ice Age. Longer term, it's impossible to predict what will happen. It's unclear that we'll have a disaster. Asset prices will come under increased pressure, but if banks don't lend, alternative sources of financing will evolve, as they always have. This process won't come easily or quickly, but it will occur. Look at immigrant communities in America. Immigrants often have a difficult time getting credit from established financial institutions. What do they do? Band together and finance themselves. For example, within the Korean community, a half-dozen or so members may pool their savings and make loans to each other in order to finance new businesses. Each borrower repays the pool, and the pool makes a loan to another member to start his or her own business. (Credit unions and mutual savings and loan associations work the same way on a larger scale.) Angel investors for high tech startups are another example of capital bypassing the banking system. Internet based lending sites, where lenders directly interact with borrowers, are the latest example of this phenomenon. If the banking system fails to serve people, people will be resourceful. You may lose hope in the banking system, but don't lose hope in yourself.

Does the AIG Deal Tell Us the Financial System is Insolvent?

Congratulations. We--you, me and all other U.S. taxpayers--now own American International Group, the largest insurance company in America. This came courtesy of the Federal Reserve, which extended AIG an $85 billion emergency CPR-style loan in exchange for 79.9% of its equity. I never wanted to own an insurance company (they're less well-liked than lawyers). But life does take unexpected twists. AIG is not likely to be a profitable investment. While it has apparently sound subsidiaries engaged in ordinary insurance activities, like life, property, auto, etc. coverage, and also manages money and sells investments like annuities, its big boo boo was to dabble in credit default swaps. These puppies guarantee bondholders, often holders of mortgage backed bonds, against default. Not a profitable line of business these days. We, the new owners of AIG, are likely to take some big losses as a result AIG's dalliance with derivatives.

Recent efforts to arrange a private sector loan for AIG provide some disturbing information. News reports indicate that the Fed and the Treasury leaned heavily on a number of major U.S. and foreign banks to provide AIG with a $75 billion loan. But the banks evidently couldn't do the deal. They had every incentive to do the deal, because a collapse of AIG could seriously impair their own viability. But if they couldn't make this loan even if their survival was at stake, one begins to suspect the financial system as a whole may be insolvent. If you tallied up all of the major financial institutions' assets and liabilities (the latter are the tougher question), would you end up with a negative net worth? Such may have been the case in Japan during the 1990s. Japan has paid a heavy price for the reckless lending of its banks, in terms of low growth and diminished prospects. Is the same in store for America? Federal bailouts like the acquisition of AIG can prevent short term financial panic. But they also spread out the pain over a longer period of time to a larger group of people. There is no avoiding the pain. The only question is who will bear it and when. The nationalization of AIG clarifies the answer. If you want a hint, look in the mirror.

The Wall Street Bubble Bursts: Unraveling a Bet on Government Policy

Today, September 15, 2008, the Dow Jones Industrial Average dropped 504 points. The proximate cause of this downturn was the bankruptcy filing of Lehman Brothers and highly publicized problems at other financial services firms, such as Merrill Lynch, American International Group, and Washington Mutual. Even well-regarded firms such as Goldman Sachs and J.P. Morgan Chase are experiencing downdrafts in their stock prices. The Wall Street bubble is bursting.

There are different ways to explain the bubble and its demise. Wall Street took on too much risk, based on a belief that it could be spread around with increasingly complex derivatives contracts. The big banks relied too much on historical data showing that real estate prices had never dropped on an aggregate national level since World War II. They borrowed extraordinary amounts, becoming more leveraged than many hedge funds. They believed themselves too big to be allowed by the government to fail, and acted like teenagers in the driver's seat who believe they won't make a mistake. Perhaps less well understood, though, is that Wall Street made a bet on government policy, a bet that started off well but ended badly.

Since the inauguration of Franklin Roosevelt in 1933, the federal government has taken a greatly increased role in the nation's economy. It insures bank deposits, regulates stock markets on a national scale, uses fiscal, monetary, tax and other policies to promote economic stability and growth, and buffers citizens from the colder, harsher winds in the capitalist world with unemployment insurance, Social Security, Medicare and Medicaid. Americans became accustomed to federal assistance whenever times got tough.

The government's policies did more than just soften the edges for individual citizens. They also took risk out of the markets, especially the real estate and financial markets. Federal agencies created to promote financing for home purchases, such as Fannie Mae, Ginnie Mae, the FHA and Freddie Mac, did much to support and perhaps increase real estate prices. Federal bank regulation, especially the central bank administered by the Federal Reserve and federal deposit insurance, buffered bankers from real world risks of poor operational performance and ensuing deposit flight. It became easy for financiers to become complacent, and they did what came easily. If you don't have to face the downsides of risk, it makes sense to take on more risk and increase your potential for profits. To make things even more copacetic, the Federal Reserve maintained an easy money policy starting in the mid-1990s, lowering everybody's cost of doing everything and making risk seem attractive rather than dangerous.

However, a copperhead remains a copperhead even if you put lipstick on it. And, contrary to the conventional wisdom of the Fed fast money days, chickens retain the habit of coming home to roost.

When the mortgage crisis and credit crunch broke in the summer of 2007, the federal government rode to the rescue, as had come to be expected. Casting aside considerations of moral hazard and burdens on taxpayers, the Fed became a lender, sometimes of first resort, for a variety of financial institutions (and not just commercial banks), accepting both good and potentially murky assets as collateral. Then, when Bear Stearns nosedived in March 2008, the Fed issued a $29 billion check to J.P. Morgan to induce it to buy Bear Stearns. Just last week, the Treasury Department nationalized Fannie Mae and Freddie Mac, in order to prevent worldwide financial distress.

But bailouts cost money, and no government has unlimited resources. The U.S. government was relying on its borrowing power to finance these bailouts. But its deficits are humongous, and growing rapidly. America's overseas creditors have lately been frowning at the dollar, and quietly shifting wealth into other currencies. Smelly things were getting close to the fan. The Treasury Department apparently realized that it couldn't keep signing chits for Wall Street bailouts, not when firms the size of Lehman, Merrill, AIG and Washington Mutual belly up to the bar for their drinks on the house. So Lehman wound up in bankruptcy, Merrill was bought by Bank of America, and AIG and Washington Mutual are selling whatever apples they can on the sidewalk.

Much of Wall Street bet that the government would continue its policies of subsidizing real estate and protecting the largest financial institutions. The government's early response to the financial crisis only fueled these beliefs. But too many banks made too many bad mortgage loans for the government to absorb. Government policy can't be implemented beyond the government's resources. Wall Street's bet on government policy turned out to be a bad bet.

The largest financial institutions now realize that, for the first time in decades, they are exposed to market risk. Indeed, the government's new policy is to expose them to market risk. This likely means more losses, writeoffs, acquisitions and perhaps bankruptcies. The stock market is more likely to fall than rise in the near term. Main Street will lose much of its credit as banks' capital levels shrink, diminishing their ability to lend. Economic activity will probably slow and a recession would hardly be surprising.

Not that all is bad. Requiring Wall Street to reckon with market forces, unsoftened by government largess, will strengthen the financial services industry. The strength of any industry ultimately rests not in the quantity of its capital but the perspicacity and wisdom of its leaders. Few of Wall Street's current or recent leaders have proven to be strong. A good thrashing by market forces will change the picture. It remains to be seen whether the government will yet feel compelled to step in and once again administer financial methadone. But sparing the rod has only spoiled the executive suite. And a lot of Wall Street executives have spoiled a lot of things for a lot of other people. It's time for change.

Why We're on the Road to a Federal Bailout of Lehman and Others

A federal bailout of Lehman Brothers in the near future is a near certainty. It probably won't be the end. More federal bailouts of large financial institution are likely to be in our future. Here's why.

Real estate and mortgage losses continue to abound. A lot of these losses remain unrealized on the books of major financial institutions and may grow as payments pop on option ARMs written two and three years ago. Foreclosure rates are rising and much of the relief provided by the Bush Administration's mortgage aid package from last year simply defers payments instead of reducing them. A lot of people who can't make the payments now won't be able to do so later, not when we have a slowing economy and rising unemployment. So losses are deferred but remain to be recognized. To make things worse, the commercial real estate market is getting uglier by the day.

Losses in commodities trading are rising rapidly as oil, gold, silver, platinum, corn, wheat, copper and other commodities deflate in value. Since commodities trading is heavily leveraged, the banks that financed these transactions, as well as hedge funds and other speculators, stand to book losses. Thus far, little has been said publicly about these losses, although a large hedge fund, Ospraie Fund, has shut down because of poorly performing commodities-related investments. More commodities losses will surface sooner or later and take their toll.

Credit card, car loan and other credit losses are on the rise, just at a time when investors are increasingly reluctant to buy securitizations of all types of loans. Banks have nowhere to go with an ever stinkier loan portfolio.

The U.S. and worldwide economy are slowing and unemployment is rising, making it more difficult for banks and other financial firms to work their way out of their losses.

Last, but certainly not least, the "too big to fail doctrine" discourages private capital infusions. Having booked monster losses, and with even uglier monsters looming in their financial futures, many large banks desperately need to raise capital. The financial sector's depleted capital is like a weakened immune system, and capital infusions are the way to buck up the patient. But the "too big to fail" doctrine employed by the federal government in the recent Bear Stearns, Fannie Mae and Freddy Mac bailouts includes substantial elimination of the interests of stockholders. That policy makes sense. If stockholders are at risk of total or near total loss from federal intervention, they presumably will hire competent management who will prudently avoid the need for a federal bailout. But this policy also means that a seriously distressed bank large enough to qualify for "too big to fail" treatment won't be able to find private capital. Investors will be concerned that they could pony up their money today only to be squeezed out by the feds three months hence. In effect, the "too big to fail" doctrine means that the federal government is the only salvation for major financial institutions when they become seriously impaired. The smart money will wait for the federal bailout, figuring that a year or two from now, when the feds are reorganizing the bailee and selling off its assets, private investors can buy those assets at a better price than investing in the failing banks today.

So, get used to the idea of more federal bailouts, and a bigger federal deficit to pay for them. The stock market seems to be getting used to them. The 290 point gush in the Dow after the announcement of the Fannie/Freddie bailout dissipated the next day. Another day, another bailout.

Weird Food News: man claims to have eaten 23,000 Big Macs. http://www.wtop.com/?nid=456&sid=1474861.

Ins and Outs of the Fannie Mae-Freddie Mac Bailout

IN:

Foreign Governments Holding Fannie and Freddie Debt. Large amounts of Fannie and Fred debt are held by foreign central banks. A collapse in the value of this debt would not only have financial consequences, but foreign policy consequences as well. With all the foreign policy problems the Bush Administration has right now, it doesn't need Fannie and Freddie to muddy the waters even more. These foreign governments and other foreign investors provide much of the financing for the U.S. government and the U.S. economy. Leaving them with big Fannie and Freddie losses would make them feel like they made a bad bet, which would have a detrimental effect on foreign relations.

Other Debtholders. All the mutual funds, pension funds and other investors holding Fannie and Freddie debt are sitting pretty, with explicit federal guarantees now bailing them out of market risks. Uncle Sam is the richest uncle of all, and it's nice to have him helping you out.

Republicans. With the housing market still headed downward, and credit remaining badly crunched, the Fan/Fred situation would only have gotten worse as Election Day approached. By stepping in now, the Bush Administration provides some short term stability and takes ammunition away from the Democrats. The long term problems will be left for the next President and future Congresses. The nationalization of Fannie and Freddie make sense for a lame duck administration that would find redemption in the election of Republican successors.


OUT:

Common Stockholders. In a corporate reorganization or liquidation scenario (it could be either with Fannie and Freddie), common stockholders are last in line to be paid out. Lots of luck, folks. You got the biggest returns when times were flush and you get coal in the stocking when times are tough.

Preferred Stockholders. Preferred stockholders are next to last to be paid out, and there's a lot of low-priced Fannie and Freddie preferred stock for sale in the market today. Be cautious about buying it. A low price may not be a bargain. The government has suspended Fannie's and Freddie's dividend payments, so the preferred is a pure speculation and the odds may be rather bad.

Top Management. The highest ranking executives at Fannie and Freddie lost their jobs. It remains unclear whether they should be tarred and feathered before being booted out of town. But they weren't fixing the problems, and that's what management should do regardless of who is responsible for the problems.

Lobbyists. A vast herd of lobbyists on the Fannie and Freddie payrolls are weeping at the news that the federally controlled Fannie and Freddie will not engage in any lobbying activities. This is perhaps the best decision made by Secretary Paulson and his colleagues in connection with the federal takeover. Fannie and Freddie have, for decades, deployed lobbyists to suppress almost all efforts to reform the way they operate. Rarely has any interest group fed so gluttonously at the public trough as have Fannie and Freddie. Fannie and Freddie have used political power and the implicit/explicit federal guarantee of their obligations to insulate themselves from market forces. Thus, they didn't have effective risk management, because they didn't think they had to face risk. By putting a stop to the lobbying, the government has an opportunity to evaluate and address Fannie's and Freddie's problems with greater objectivity.

Democrats. While both parties have much blame to bear in connection with Fannie's and Freddie's problems, the Democrats deserve the greater share. They have, while accepting generous campaign contributions from Fannie, Freddie and their running dogs, blocked legislation that would have converted these entities into true market-based entities. Then, Fan and Fred might have been forced to institute effective risk management processes. Had they had real risk management, we wouldn't be where we are today. The Democrats have lost the political power Fannie and Freddie wielded.

Fannie and Freddie. Fannie and Freddie as they now exist are among the biggest losers. They will either be reformed or dismantled. They won't continue business as before. All the better, since business as before will cost taxpayers a mountain of money at a time when the federal deficit is metastacizing. It would be best to put Fannie and Freddie down. News reports indicate that they continue to engage in potentially questionnable accounting. Does anyone know how much unrealized loss Fannie and Freddie still face? They should be liquidated, like the bad S&L's from the 1980s. In their place, the FHA and Ginnie Mae, which make explicit federal guarantees, can be given expanded roles. Or a new federal housing finance agency with a clean balance sheet can be created. It, like the FHA and Ginnie Mae, should provide an explicit guarantee of the mortgage. When federal agencies make explicit guarantees, they maintain meaningful credit standards--no loans for those with no incomes, assets or discernible employment. Thus, they should spend much less time reaching for the taxpayers' wallets.


Sister Kisses: There are also those who receive kisses from their sisters in connection with the federal takeover of Fannie and Freddie.

Home Buyers. The nationalization of Fannie and Freddie will probably lead to a small dip in mortgage rates. But credit standards will remain high: you'll still need a real downpayment, verifiable income and assets, and a decent credit history. And fees for federally guaranteed loans will put a dent in your cash balance. Large numbers of the buyers at the late stages of the real estate boom didn't meet these standards and they won't be able to get loans now. So, if you're a good credit risk, you may get a slightly better deal on your mortgage. Otherwise, little has changed.

Home Sellers. The late stages of the real estate boom produced extreme prices that many home sellers still think they can get. Those prices, however, were made possible only by a flood of really stupid mortgage loans to borrowers who had no identifiable ability to repay. The nationalization of Fannie and Freddie will not bring about a renewal of stupid lending, and extreme prices won't be paid in the foreseeable future. Housing prices will probably continue their overall decline until who knows when.

U.S. Economy. The federal takeover of Fannie and Freddie may slow the decline in the real estate market. But it won't produce a resurgence. At the same time, the cost of the bailout will increase the federal deficit and could exert upward pressure on interest rates as the federal government borrows more to pay out Fannie and Freddie debtholders. The nationalization of Fannie and Freddie staved off panic in the debt markets. But it won't do much to revive the economy.


Crime News: We are glad to report that a stolen mechanical gorilla has been found. http://www.wtop.com/?nid=456&sid=1471349.

The Logic of Bailing Out the Auto Companies

The three American auto manufacturers--GM, Ford, and Chrysler--are reportedly planning a lobbying campaign to secure $50 billion in loans at favorable interest rates from the federal government. This money will supposedly allow them to shift more rapidly to fuel-efficient models, a laudable goal. The political winds are behind this idea.

As a matter of principle, a taxpayer funded bailout of the auto companies is a bad idea. In a market economy, private enterprise should profit by dint of its own diligence and perspicacity. And it should takes its lumps without looking for government subsidy. If you have to pay for your mistakes, you'll learn to avoid making them. And the American auto companies have made a boatload of mistakes, ranging from decades of mediocre quality and design to betting the ranch on a single factor--the price of oil. They thought that clever marketing could fool consumers into buying inferior products, and competed against each other when the real competition came from overseas. Even now, one wonders whether they'd make wise use of $50 billion of low cost federal loans. Optimism in this respect isn't necessarily warranted.

Nevertheless, there is a good reason to bail out Detroit. The U.S. is too heavily invested in real estate. Since the Great Depression of the 1930s, the federal government has been subsidizing home purchases one way or another, with tax deductions, federal deposit insurance, and the creation of a vast secondary market for mortgages. Things really got out of hand in recent decades, with Fannie Mae and Freddie Mac reaching Brobdingnagian size and the Federal Reserve keeping interest rates lower than a snake's belly. When you do anything to excess, you'll pay the price, and we're paying the price now.

As real estate values sink lower while mortgage defaults spread like a Medieval plague, the financial markets clamor ever more loudly for a federal bailout of defaulting homeowners. Since just about everyone on Wall Street, from big firms to institutional investors to hedge funds, has substantial investments directly or indirectly linked to real estate, the cries for government intervention ring from sea to shining sea. The Bush administration has been unable to resist these demands, recently making explicit the federal government's formerly implicit guarantee of Fannie and Freddie while promising to assist many distressed homeowners.

But the welfare queens on Wall Street still aren't satisfied, as calls are yet made for federal purchases of distressed properties and more subsidies for home loans. With this being an election year and the Bush administration having abandoned all pretense of favoring a market-based economy, surely more hair of the biting dog is headed for the real estate and mortgage markets.

That, however, will only continue America's over-investment in real estate. The heart of any industrial economy is its manufacturing sector. America's manufacturing sector has been suffering through hard times since Richard Nixon scowled from the Oval Office. It has survived, although with many adjustments and major losses. The recent decline of the dollar has improved export business. But American manufacturing is a hollow shell compared to the mighty juggernaut that built vast quantities of aircraft, ships, tanks and trucks for the victorious Allies in World War II.

Subsidized loans for the American auto companies would help protect America's manufacturing base. The auto companies employ hundreds of thousands, and their suppliers employ hundreds of thousands more. The health of the U.S. economy cannot be sustained by yet more government funded bets on real estate. Business enterprises produce more overall wealth than real estate. This is evidenced by stock market prices, which have historically increased about 3% above the rate of inflation, while real estate values have increased about 1% above inflation. If the Bush administration is going to continue its socialization of the economy, it should diversify its focus and give a little to manufacturing. More concentrated bets on real estate will only set the stage for the next bubble and collapse, with even greater losses to be borne by taxpayers.

Boosting America's wealth is the only way to deal with the demographic problem of an aging population. While increased immigration could improve the ratio of workers to retirees, the political landscape precludes relaxing the borders. So emphasizing economic growth is perhaps the only way to keep retirees and workers from being less well-off than their parents.

Do the American auto companies deserve government subsidies? Absolutely not. They're responsible for the problems they now have--Toyota and Honda simply made smarter bets on fuel efficient car and engine designs, while maintaining better overall quality. But America has to diversify away from real estate. Almost all of the federal bailout money for Wall Street and real estate will go to the undeserving. Since the Bush administration is proceeding to socialize much of the economy, it ought to do it in a way that offers long term benefits rather than short term expediency.

How to Avoid Having Unclaimed Property

There are billions of dollars of unclaimed property. We've written about a number of ways you can find out if a state or the federal government is holding property for you. See http://blogger.uncleleosden.com/2007/05/unclaimed-money.html. Better than having unclaimed money, though, is making sure you get everything that's yours in the first instance. Here are some ways you can avoid having unclaimed money.

Cash or deposit all checks. This may be one of the most typical sources of unclaimed money. Small checks for dividends, rebates, credit card cashback awards, refunds and the like almost seem like an annoyance, and the rise of Internet banking doesn't make it easier to deal with them. But make sure you cash or deposit all of them. A brief look at the numbers will tell you that these little checks add up. Let's assume you get $50 a year, after taxes, of annoying little checks over the course of a 50-year adulthood (mid-20s to mid-70s). We'll also assume that you're thrifty and save this money, earning 6% a year return on it. At the end of the 50 years, you'll have about $14,500. Adjusted for inflation of 3% a year, you'll have about $3,165. That's enough for a nice Carribean or Alaskan cruise. You could play a lot of shuffleboard and pig out at buffets if you just deposit all your checks. If you're not careful about these little checks, it's easy to let $50 a year slip out of your hands. Just remember that, with a little more diligence, you could taken a cruise.

Claim all rebates, refunds and rewards. One reason manufacturers like to offer product rebates, instead of just lowering prices, is that many people don't claim them. They just can't be bothered with the paperwork, which is usually enough to be annoying. Then, the manufacturer gets the best of both worlds. The consumer is lured in by a rebate, believing that he or she is getting a deal. But the manufacturer makes a sale without having to actually lower the price. Claim all rebates, refunds, and cashback and other rewards. A nice cruise is at stake. If you don't, many of these claims may not show up on government lists as unclaimed property--because it's not yours unless you try to get it in the first instance.

Keep track of your assets and organize your financial records. This may seem obvious, but it gets harder as you progress through your career, prosper and begin to accumulate all kinds of assets that seemed like a good idea at the time you invested in them. But as stocks split, mutually owned insurance companies and savings and loans become stock corporations, banks change their names, married couples holding property jointly get divorced, and so on, keeping track of all assets becomes harder and harder. People are busy and paperwork is a hassle. Data in hard drives is lost as computers are replaced and downloadings are incomplete. But not keeping track of assets means you're losing them. Take the time and trouble to keep track of what is yours. Maintain your records, for a long time. If one of your assets somehow becomes unclaimed property, you may need an ancient account statement or stock certificate to prove that you are the true owner who was last heard from 15 or 20 years ago. If you lose an average of $50 a year over the course of your adulthood because of sloppiness and laziness, another Alaskan or Carribean cruise goes down the drain.

Update your address. Another common way people lose money and other property is to fail to update their banks, brokerage firms, mutual funds, 401(k) administrators, insurance companies and other financial firms with changes of their address. This should be a nobrainer, but some people . . . .

Respond to legitimate inquiries about your accounts. Sometimes, you might get an inquiry from a bank or other firm to verify that an account is yours. Make sure the inquiry is legitimate (never give out information over the phone or in response to an unsolicited e-mail). But respond to all legitimate inquiries. Otherwise the bank or other firm might turn your account over to a state agency as unclaimed property.

Leave jobs on an informed and fully compensated basis. Whenever you leave a job, make sure you find out the status and balance of any retirement accounts you have. Very important are 401(k) and employee stock option plan accounts--get account numbers and balances, and find out what options you have to keep them with the employer, transfer them and/or cash them out. If you're lucky, you might also have a traditional pension plan account. Find out if you're vested, when you might start collecting benefits, and what options you have. Collect all of the commissions, bonuses, awards and compensation you've earned. Cash out your accumulated vacation time and sick leave, if possible. Exercise your stock options if possible. Check into the situation with deferred compensation and restricted stock. For more information about things to think about when leaving a job, see http://blogger.uncleleosden.com/2007/05/financial-checklist-for-job-loss.html.

File tax returns--and deposit the refund check. Taxes are inevitable, but tax refunds aren't. You have to file a return in order to claim your refund. Amazingly, some people don't file returns even though they're entitled to refunds. Don't pay more than your fair share of taxes. File for your refund. Even more amazingly, some people don't deposit their refund checks. This violates the first rule of avoiding having your property be unclaimed. Deposit your tax refund checks. Better yet, have the refund electronically deposited into your bank account.

Blowback from the Treasury's Authority to Bail Out Fannie and Freddie

The Treasury Department received the authority to bail out Fannie Mae and Freddie Mac in the mortgage assistance law signed by President Bush on July 30, 2008. This law gave Treasury the power to lend Fannie and Freddie an unlimited amount of money and to invest in their stock or other securities on whatever terms Treasury thought were appropriate. The idea was that the presence of the bailout authority would reassure investors and the financial markets, and allow Fannie and Freddie to seek new infusions of capital from private sector sources. Assuming private capital could be obtained, no government money would be needed and there would be no risk to the taxpayers.

Just the opposite seems to have happened. The real estate markets continue to decline, because losses from the mortgage crisis get larger every time we turn around. The rates of defaults and foreclosures are still rising, because so many mortgage loans have escalating payments that borrowers can't meet. These ever-increasing loan failures depress the real estate market further, which exacerbates the losses Fannie and Freddie already face. As Fannie and Freddie write off ever larger amounts and announce more quarterly losses, private sector sources of capital become more skittish and the prospect of an actual Treasury bailout looms.

The market believes that any Treasury bailout will squeeze out current Fannie and Freddie shareholders. A squeeze-out makes sense, because stockholders shouldn't be protected at the expense of taxpayers. But the risk of a squeeze-out further discourages potential investors from providing Fannie and Freddie with new capital. Why invest in these loss-laden behemoths only to be squeezed out by the Treasury Department a short while later? Fannie and Freddie's stock prices have dropped about 60% this week and now trade in the middle single digits. That's the price range that companies approaching bankruptcy often trade in.

Thus, the mere existence of Treasury's bailout authority discourages investors from infusing Fannie and Freddie with new capital. That, in turn, makes government bailouts essentially inevitable. Treasury probably knows this, but may well hope to delay the bailouts until after the presidential election. Lots of luck. Fannie and Freddie reportedly have to roll over some $225 billion in debt in September. Just two days ago, Freddie had trouble placing some $3 billion in 5-year notes, paying an unusually high interest rate. How will Fan and Fred refi $225 billion in September given the current state of affairs? A Treasury bailout may have to be done soon. Real soon. Maybe Treasury will offer Fan and Fred a Labor Day weekend special rate on new capital. Perhaps the end result will be their nationalization.

That wouldn't be a bad thing if it's handled properly. They're close to nationalized anyway, and someone's got to staunch the bleeding at these gray elephants. But the people running Fannie and Freddie have proven in abundance that they are not up to the job of properly intermediating the mortgage markets. Fannie and Freddie should be eased out of the business of buying new mortgages, and gradually liquidated. The Fannie/Freddie model--private profit with the risk of loss socialized--must be taken to Boot Hill.

One or more new agencies should be created to replace Fannie and Freddie. This time, let's make the government guarantee explicit, as it is with Ginnie Mae, the one mortgage intermediator who doesn't seem to be in trouble. That's because Ginnie Mae maintains high standards for the quality of mortgages it buys. If the taxpayer exposure is explicit, the management of the new agencies will have to be responsible about how they go about doing things. And, as for those mortgages that are too risky for government purchase, there's always the private sector. This time, with no implicit government guarantee to do a fan dance for investors, private mortgage intermediators, who will be expected by investors to keep some skin in the game, will insist on sound underwriting of mortgages. Perhaps then the mortgage markets will actually begin to behave rationally, and real estate values will solidify instead of imitating a fallen souffle.

Putin's March Through Georgia: There Goes the Peace Dividend

The more Russia promises to cease firing and stand down, the farther Soviet forces advance into Georgia. Those forces bear the markings of the Russian Federation. But there's no doubt they represent an attempt to revive the Soviet Union, a confederation consisting of Russia as the Sun and surrounding "nations" as satellites.

It's difficult to predict when Soviet forces might pull back. They continue aggressive operations, destroying Georgian munitions, transportation facilities and military equipment. This, by any reasonable definition, constitutes the prosecution of war. Sure, Russian President Medvedev signed a truce agreement today (8/16/08). But is an agreement truly binding when the butler signs it? The Big Cheese (that Putin fellow) doesn't seem to think so.

Officials in Washington and Paris sputter their outrage. Putin is probably snickering into his sleeve. The Poles are somewhat more pragmatic, coincidentally signing up for some missile defense right after Soviet tanks again roll across a sovereign border. Poland seems to have learned from hard experience what works and what doesn't.

In the fading light of his lame-duckness, President George W. Bush has been exquisitely hoisted on his own petard. He chose Georgian president Mikhail Saakashvili as an ally. That choice was, to say the least, a misjudgment. It would probably pay off handsomely to play poker with Saakashvili. He allowed himself to be snooked by South Ossetian separatists firing off a few artillery rounds into launching the Georgian military at Ossetian territory occupied by Soviet troops. What on Earth was Saakashvili thinking? Did he expect the Soviets to apologetically retreat? Even loonier, did he think the U.S. would send in military support? Never in the 45-year Cold War were U.S. troops ordered to make a direct attack on Soviet troops. What did Saakashvili think was so golden about his rear end that U.S. military personnel would be called upon to protect it?

But President George W. Bush's miscalculations didn't stop with a bad bet on Saakashvili. His little adventure in Iraq burned out U.S. military strength and U.S. goodwill in Europe. Both are badly needed in the current confrontation with the Soviets, who really do have weapons of mass destruction. But our military can't fight another war right now. And today's Western European leaders make Neville Chamberlain look like the picture of fortitude. At least Chamberlain understood that the little man with the funny moustache was a serious threat and authorized faster rearmament of Britain's military, including the construction of the Spitfire (a fighter plane that became the darling of the Royal Air Force during WWII).

That takes us to the point of this blog. The resurgence of the Soviet Union will lead to increased U.S. military spending. It doesn't matter who wins the Presidential election in the fall. John McCain won't back down from a Soviet threat. Barack Obama can't afford to let himself appear weak in foreign affairs, lest he prove the Republican charge and lest he weaken America's ties with energy producing former Soviet satellite states in Central Asia and with newly democratized nations in Eastern Europe (who are our best friends in Europe). The next president will have to deal with the central tenet of Soviet foreign policy: might makes right. W is very weak right now, and Putin feels like he has a free hand to march through Georgia. The U.S. won the first Cold War without having a face-to-face shootout with the Soviets because American military capabilities were always enough to prevail. To hold the Soviets in check now, the U.S. will have to have comparable capabilities. That will be expensive.

From an economic standpoint, that means greater U.S. military spending, higher taxes and a larger federal deficit. Other needs--universal health insurance, fixing Social Security and Medicare, investment in alternative energy, protection of the environment--are likely to diminish in importance. Perversely, the dollar may strengthen. After all, who wants invest in a Europe threatened by thousands of Soviet tanks--or even just the cutoff of Soviet natural gas? But the peace dividend--that sharp drop off in military spending that allowed President Clinton to reduce federal spending and balance the budget--is gone, gone, gone. Even if U.S. military involvement in Iraq decreases, dollars saved from that misadventure will be needed to corral the Soviet bear. And those savings won't be enough to pay for the hardware and technology needed to counter the Soviet ability to project strength almost anywhere on the globe.

Obviously, America and Americans don't want a confrontation with the Soviets. We have enough problems. But this problem has been brewing for a long time and will be with us for a long time. Vladimir Putin ain't going anywhere any time soon, whatever democratic processes Russia may have. Russia has become increasingly defensive and even paranoid as the U.S. has co-opted many of the former Soviet satellite nations into becoming U.S. allies. If Mexico, Canada, Jamaica, the Dominican Republic and all of Central America signed up to become Russian allies, the U.S. would feel defensive too. The wounded Russian bear is snarling and lashing back. It would be inconceivable for the U.S. to try to kill the bear, but it cannot let it run loose either. It must contain the bear, and that will cost a pretty penny for a long time to come.