catch-22

You probably heard about the bail-out package. The $700 billion that is needed to "stabilize" the market. The $700 billion that will buy worthless debt "instruments" and straddle tax payers with excess pain for decades to come. But what you may not know, or may not have thought off is that this package will do nothing for struggling home-owners. It will do exactly nothing about the source the mess, the mortgage crisis.

What it will do, is allow banks to write-off or remove from their balance sheet, worthless paper. Toxic debt is the technical term. That will make the bank look better, and up its credit rating. That will make it so the bank can get more money and won't have to raise funding to shore up its collateral.

However, the plan can only work when two things happen. Things that nobody really wants to happen. Or at the very least, things that nobody should want to happen.

The first is the CEO's and other C-executives will walk away with millions in bonuses, severance, and other platinum or diamond-studded gold parachutes. All rewards for "a job well done." And there is nothing you or I or anyone else for that matter can do about it. Because those greedy executives will not sign on to a plan that forfeits their "packages." 

Guess what will happen to bank X if its CEO has to sign on to a plan that wipes out his/her package in order to rescue the company? If you said, he/she will let it go under, you win! Because that is exactly what will happen. No CEO will voluntarily give up their "benefits" in order to do his/her fiduciary duty or protect the shareholders. CEO's are eager to fire workers to protect the shareholders and boost margins, but don't touch their money!

The second is that the Fed will have to pay way too much for all that debt. If the Fed values the debt for what it is worth (nothing), then the cure won't work. Even if the Fed pays a more reasonable rate, the rescue won't work. The cure can only work if the Fed buys worthless paper for its over-inflated and unrealistic face value.

So here you have it. A package that buys useless paper at enormous cost with your money and rewards incompetent executives for their greedy misbehavior over the past five to eight years.

And what will this marvelous package do? It will restore confidence. It will make it so banks don't fail and so credit does not dry up. It will save the financial sector. It will do nothing, absolutely nothing for housing, mortgages, home-owners or anyone else. They will be left to pick up for themselves. It will do nothing about the next wave of upcoming foreclosures. It will do nothing about crashing housing prices, or lost jobs.

The banks sold everyone mortgages that they could not afford and then they packaged these mortgages with plenty of excess fat into investment "vehicles," that are now worthless because the collateral is not there (i.e. the house). So the bank has a problem, and guess what, we will bail them out.

crisis

Postponing recessions just makes matters worse. That is the lesson we learn from the current crisis. Instead of letting the economy suffer a bit after the 2000 stock market bubble, the Fed decided to give it a lift with plenty of free credit. A government subsidy that went on for too long. And what happened? People felt good... for a while. 

They felt so good they started to think how to spend their money. Suddenly, their house was worth a fortune. It had run up during the boom and now with cheap credit there was a way to cash in. Never mind those paper losses on the stock market. Here was real money and and it was easy to get it. Just refinance. Real estate never goes down now does it?

What people did not realize is that real estate does not appreciate at 40% or more year over year. Those crazy numbers were based on paper gains made in an "irrationally exuberant market." Everyone felt rich and when you are rich you pay richly. Especially those who have never been rich before (the so-called nouveau riche). They have money so they want to pay. All those stock market gains drove housing through the roof.

So here we are, after the big bubble, lots of tears about our paper losses, but hey the house is worth a fortune. And interest rates are low. Let's refinance and take some money out. Let's do some shopping. It is our patriotic duty (remember the 9/11 mantra? go out and shop).

And for those of us with gains, let's invest in the real estate market. It is safe, remember, real estate never goes down. Let's buy a few properties and flip them in a few years. After they've appreciated 50-100%. Those are normal returns, aren't they ? Real estate always goes up that way, doesn't it? Plus it is tax-deductible. Free money from Uncle Sam.

Every time interest rates moved down a notch, more calls to refinance. Sure, the Fed enabled the crisis. But mass delusions and greed made it happen. Good news all around. Lots of money to spend on credit, lots of jobs in the financial industry, lots of joy to be had.

The more people you attract the more creative they get. And the financial institutions sure attracted lots of people. It did not take long before these geniuses figured out a way to package all these loans and sell them to investors. With nice added bonuses and commissions. More air in the bubble. Soon enough the insurance guys got in the game too. Insuring debt? Why not, after all the more contracts we write the more commissions we get.

Let's not forget that all of it is safe. No risk! Who has ever heard of no risk and lots of reward? Well, in real estate of course. Real estate never goes down. Look at the last five years. See those double digit returns? That's normal, my friend. Real estate always does that. You didn't know? Better get in now that the going is good.

More air in the bubble.

Let's not worry that nobody can pay their real mortgage. Let's give them five years of low monthly payments. Negative amortization? Never heard of it. What does it mean? Well, never mind, we'll flip it before the bill comes due. Or we'll refinance again and take out some more. This party will never end.

There is an endless supply of money. Just like there is an endless supply of oil. Kool-aid someone?