TOO BIG TO FAIL?

When do we stop using taxpayer’s money to save financial institutions that made bad decisions?

In today’s American, the one thing you can expect from Government, is if you are a big company that took unnecessary risk and gambled with people’s money and lives, then you will be rewarded with bailouts – so far over $ 3.5 Trillion worth of bailouts.

Tallying up the "true" cost of the bailout is difficult, and won't be known for months if not years. But considering $3.5 trillion is about 25% of the U.S. economy ($13.8 trillion in 2007) and the U.S. deficit may hit $1 trillion in fiscal 2009; hyperinflation and/or sharply higher interest rates seem likely outcomes down the road.

At the very least, the possibility of the U.S. losing its vaunted AAA credit rating - which determines the Treasury's borrowing costs - cannot be discounted.

As Americans and global champions of choice; hoping to make a difference in world politics, we should be asking when is it going to be enough? When do we stop helping institutions that are playing a part in our demise?

A great part of our history has taught us that we are a nation that was built on taking responsibility, standing accountable and always being the beacon for better decisions than those around us. For that reason it is incomprehensible to allow financial institutions (who have got us in this mess) to dictate the direction this country and world should take.

Last week, CIT was on the brink of collapse. The financial lender, which had already received $2.33 Billion of TARP, was refused another lifeline from the Government. A $3 Billion rescue from its debt-holders may still not be enough to prevent bankruptcy. What is interesting in all of this is the fact that the Government decided CIT was big enough to fail - whereas Wall Street institutions, which hold toxic debt from mortgages, credit default swaps and collateralized debt obligations, had to be rescued. CIT, which finances American businesses despite its failures, does not hold the above toxic debts.

I do not think we should have another taxpayer bailout for CIT, but I do see the discrepancy between one organization and another. It appears that the Government want to throw taxpayer money at the top tier of companies, who in turn award their failed leadership with bonuses.

This terrible disconnect is hurting the hard-working American businessperson and dividing a country into those that deserve Government assistance and those that have to learn to fen for themselves. The average American feels a disincentive to work when he sees people getting rewarded for failure at his expense.

AMERICAN INNOVATION WILL RESUSCITATE THE ECONOMY

But entrepreneurs need lenders to give them a helping hand

The one thing Americans have maintained is the resolve to dream up inventions, generate new ideas and ultimately provide the world with organizations like Google, Apple and Facebook.

The opportunity for innovation and improvement is stronger today than it has ever been. No-one should assume the American spirit for entrepreneurship is over. Far from it – today young businesses, new graduates and fresh-faced leaders are pioneering the way for the economy of the later part of the 21st Century.

It seems the only obstacle in their way is lending – or the lack of lending. Lenders are reluctant to supply credit for businesses especially new start-ups, despite the Government’s efforts to pump billions into banks.

Bank analysts are monitoring asset quality very closely—credit deterioration is occurring throughout the industry, raising concerns from both regulators and the market. In times like these, banks first must stop the bleeding, before they open up the purse strings and are willing to become more aggressive in their lending practices to small business.

Behind close doors the bankers will tell you that this will not happen anytime soon and we have yet to see the bottom of this downturn.

To further exasperate the situation, the bank’s lack of lending has provoked criticism of bailout programs like Troubled Asset Relief Program (TARP) and skepticism of whether Obama can really revive the banking system.

One certainty throughout all of this is the simple reality that if banks cannot support the country’s innovators, they will play a huge part in prolonging this economic downturn.

Banks have a duty to lend money to those who will drive this nation and the rest of the world – the one thing this nation has always done and always done well.

THE GREAT DELEVERAGING OF 2009:

If companies want to avert bankruptcy, they have to purge their debts


The ‘D’ word has not only reared its ugly head, it is here to stay. Banks and businesses across the western hemisphere have to begin ridding themselves of a balance sheet financed by debt.

For those of us still grappling with this technical term – a dictionary description will tell you that deleveraging is: “The reduction of financial instruments or borrowed capital previously used to increase the potential return of an investment. It is the opposite of leverage.”

Now what this delightful explanation omits to mention is that companies which are highly leveraged – one’s which have borrowed a lot of money – are at a huge risk of bankruptcy if they are unable to make good on their debts.

Financial institutions are currently underway with the process of calling back loans especially from those who are seen as high risk borrowers. This is resulting in increasing the cost of credit for the rest of us and a drop in the value of investments.

Deleveraging isn’t only affecting banks and businesses – it is affecting homeowners as well. Real estate information supplier, Zillow said that 20% of American mortgage holders owe more on their home than the home is worth. At the same time more people are foreclosing on homes and when those homes go to be sold, there is a huge decline in price. There is little doubt that the real estate market has to follow in the deleveraging process to be able to sustain itself in the future.

The end result is that the spending patterns for both the consumer and business will languish and home valuations will continue to be under pressure back to 2003 levels relative to gross incomes. Paying down debt will take precedence over spending and business "Top line" earnings will be challenged. The reversal of this trend will take a few years to overcome.

An important footnote to all of this is the effect on the emerging economies. The International Monetary Fund (IMF) has said because emerging economies are reliant on external funding (from developed nations); they will need to adjust monetary policy to prevent capital outflows. They concluded that theses emerging markets are vulnerable to the deleveraging realized in advanced economies – like ours.

This crisis is indeed global.

SEPARATION OF BANKERS AND BROKERS:

If Congress hadn’t reversed a six decade old legislation, would we be in the mess we are today?

There is a legitimate reason why Thomas Jefferson insisted on the separation of Church and State – despite having deeply religious convictions, he understood that intermeddling between the two would be “dangerous” and “injurious to others.”

A hundred and fifty one years after Jefferson's guidance to us all, the US Congress passed a piece of legislation known as the Glass-Steagall Act – in the aftermath of the Great Depression.

The Glass-Steagall Act of 1933 was also resolute in its belief in separation - that is the separation of commercial and investment banking. Congress cited that “bankers and brokers were sometimes indistinguishable” and “mixing” commercial and investment banking had led to “conflict of interest and fraud.”

This economic stabilizer, which prohibited a bank holding company to own other financial institutions and arguably refereed institutions was repealed by the Clinton Administration in 1999 and replaced with the Gramm-Leach-Bliley Act.

At the time only eight senators voted against the measure, while the rest allowed deregulation of banks, allowing them to merge with investment houses and insurance companies. It was the era of the “megabank” – a bank so big it couldn’t possibly be allowed to fail.

One of the first banks to take advantage of the new law was Citigroup, which was the largest US bank by assets in 1999. It was now allowed to underwrite and trade mortgage-backed securities, collateralized debt obligations and create structured investment vehicles (SIVs).

Almost ten years later, the US Government gave Citigroup $306 Billion to prevent it from collapsing from losses of toxic debt.

Looking back we cannot downplay the significance of repealing the Glass-Seagall Act. It is not the only factor in the current crisis, but it did blur the lines between commercial and non-commercial banking activities – in short banks over-leveraged, took unregulated risks and brought a nation down on its knees.

Senator Christopher Dodd (D-Conn), Chairman of the Senate Banking Committee said in 1999 after Glass-Seagall was repealed: “I welcome this day as a day of success and triumph...”

Food for thought!