The new capital of America's financial system is not Washington, D.C. It's Beijing.
The financial press will report that the big story this weekend is that the Republicans and Democrats finally agreed on the details of a bailout deal to "save" the economy from imminent collapse. But that is not the story at all. In fact, it's pretty nauseating to see the self- congratulatory smiles on the Senators and Congressmen and women who are on board with the Paulson plan. What have these morons wrought?
Well, on the face of it, the bailout deal is pretty much the program Henry Paulson asked for, with a few bells and whistles to make everyone else happy. It gives him some discretion to negotiate warrants on behalf of the U.S. taxpayer. That gives the taxpayers potential equity in financial firms. Just what we needed.
One interesting rider to the legislation is that it gives the Securities and Exchange Commission the discretion to suspend mark-to-market accounting rules. That could come in handy. If firms don't have to mark troubled assets to market for awhile, they can hang on to them and hope for things to improve. It's also possible that the suspension of the mark-to-market accounting standards is just the cover Team Paulson needs to buy the assets at the non-market (much higher) price.
Don't forget what this bailout deal is all about: recapitalising the banks. You can't do that if you pay them twenty cents on the dollar. The politicians will call it many other things. But you can imagine that behind closed doors the choice was pretty clear. Let the banks get dragged into insolvency or borrow from abroad to recapitalise them.
It amounts to both a wealth transfer and a power transfer. The national penalty for wasting all that capital on a fraudulent housing boom is America's increased dependence on foreign borrowers. The remaining financial institutions not forced out of business have had to partner up with non-U.S. investors, who will now own a piece of future U.S. financial earnings.
Let's not get ahead of ourselves either. When a company goes public, it has to stage a road-show and sell itself to investors. Congress may agree to the concept of borrowing US$700 billion for its nifty bailout deal. But now Hank Paulson has to go out and actually raise that money. And who do you think he will be asking? That's right...China, Japan, Saudi Arabia etc.
There's no guarantee the money will be forthcoming. If it can't be raised abroad (which gives non-U.S. investors a call on future U.S. tax revenues via interest), then the Fed will have to create new money for it. Either way, the people in Washington should realise they are selling their nation into indebted-servitude. But then, they've been doing it for years.
Share markets will probably rally on the news of the bailout deal. And it does seem to close out at least one chapter of the credit crisis. Other things will have to happen, of course. Banks will have to lend. Spreads between inter-bank lending rates and the Fed target rate will have to come down. And the markets must dodge further disaster from the Alt-A mortgage sector and, ye gads, commercial real estate. But how much the banks stand to lose from those developments is not on anyone's radar yet.
What's happening here in Australia? Well, the share market will probably get some relief this week. Are there any buyers out there? We'll find out soon enough.
But now there are rumblings about the Aussie housing market. "Sydney house prices could fall by as much as 30 per cent in the next two years," reports News.com.au "Morgan Stanley chief equity strategist Gerard Minack said prices could fall by as much as 25-30 per cent in the next two or three years if Australia fell into recession, and by 10 per cent or more if we have a soft economic landing."
Ouch. And it's not just Minack. "The International Monetary Fund recently said Australian property was among the most overvalued in the world. It said at least 25 per cent of the increase in value over the past decade could not be justified, leaving the market ripe for a correction."
A bear market in shares and a bear market in property at the same time? That is not the sort of thing to boost consumer confidence or spending. And with business spending falling off a cliff due to the credit crunch, who does that leave to carry the spending burden?
Well, it could be that the economy doesn't need more spending right now. Perhaps it needs more investing. But the Prime Minister is having none of it. The Daily Telegraph reports that Kevin Rudd has already outlined quite a few "nation building" projects to be financed from the $20 billion "Building Australia" fund.
Australia paid off its government debt in 2006. But maybe Rudd feels left out from the great government debt binges in the U.K. and U.S. For twelve years, the Australian government has been a net creditor, with surpluses exceeding government borrowing. It now appears prepared to borrow again.
You can have an interesting economic argument about whether government should borrow to build national infrastructure assets. But it's no wonder people are so comfortable and used to being in debt. It's a way of life in the Western world.
It wasn't just Wall Street greed that led to the crisis. That is what the politicians want everyone to believe as they draft a. But the very same Washington politicians encouraged Fannie Mae and Freddie Mac to extend the dream of homeownership to as many people as possible, regardless of whether they could afford it. And when warned by regulators that the Government Sponsored Enterprises posed a risk to the financial system, Congress hid behind the idea of home ownership.
Now they want to blame it all on the lenders. There is plenty of blame to go around, although no one seems willing to accept any. Instead, we want to pretend that borrowing doesn't have consequences and that wasted money can be instantly replenished with the bailout deal. It's juvenile thinking.
Perhaps that is why the American government is now in the position of asking for allowance money from China the way a 15-year old asks for extra money on the weekend. Let's hope China says yes. Maybe they'll extend our curfew too.
Dan Denning
The Daily Reckoning Australia
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About the Author
Dan Denning is the author of 2005's best-selling The Bull Hunter (John Wiley & Sons). He began his financial publishing career in 1997 and has covered financial markets form Baltimore, Paris, London and, beginning in 2005 Melbourne. He’s the editor of The Daily Reckoning Australia and the Publisher of Port Phillip Publishing.
Comment by Paul Langley on 29 September 2008:
Your article 'Bailout deal will expand China..... 29th September -
re. Morgan Stanley equity strategist, Gerard Minack predicts 25-30% drop in house values over the next 2-3 years if a resession and 10% if we have a soft landing.
Does this guy work, currently, for the same Morgan Stanley whose shares dropped about 50% over a 2 day period a fortnight ago and who then went begging to Wachovia to do a deal before the Fed. rescued them with a free commercial bank licence. Did Gerard the equity strategist, read expert, predict this for his masters. Interesting how many equity experts are suddenly expert commentators on real estate.
Comment by Steven Shaw on 29 September 2008:
I hear that Australia is debt free too. However, I went to the Australian Office of Financial Management - http://www.aofm.gov.au/ - the other day and it said that it managed a $50b debt. I recall reading somewhere that the govt still issue bonds now simply to support the bond market. Does the govt hold $50b in debt when it doesn't really need the money?
Comment by kayle on 30 September 2008:
@ Steven Shaw
Australia is by no means debt-free.
Australia's level of private debt is among the highest in the world.
Check Steve Keen's Oz Debtwatch blog for details on Australia's dangerous level of private debt. This credit deflation puts our entire credit-based economy at risk.
Or - just glance at Wikipedia's list of Current Account Balances by country (runs from surplus to deficit).
Out of 164 countries, China is of course first. Japan second, Switzerland is way up there too.
Out of 164 countries, USA is dead last. Spain, UK, and Italy are nos. 161-163, and 160 is - you guessed it - good ol' Australia.
Anyone who thinks we are safe from this global crisis is either lying or deluded.
My currency investments are long yen and swiss franc. Short the dollar and euro; the only way I'd feel safer is if I actually move to Dubai.
Comment by Robert on 30 September 2008:
Is it true that the only reason that the banks are being bailed out without loss of equity is that the international investors that support the American consumption economy may be upset and remove all their funds. Thereby crashing the dollar and the US.
Comment by Steven Shaw on 30 September 2008:
Thanks kayle. I am aware of the debt crisis and Steve Keens blog (I am particularly worried about Steve's poposed solutions to the debt crisis i.e. printing money).
I was talking about govt debt. Sorry for the confusion.
Comment by Moobi on 30 December 2008:
"Perhaps that is why the American government is now in the position of asking for allowance money from China the way a 15-year old asks for extra money on the weekend. Let's hope China says yes. Maybe they'll extend our curfew too."
The arrangement seems to be between America and China, how did "our curfew" get into there? Sounds like a demogogue who'll grab the cash but spurn the lender.
Comment by Drew on 30 December 2008:
@kayle
"Australia is by no means debt-free.
Australia's level of private debt is among the highest in the world."
I think that it should be kept in mind you can't blame the Australian government for that. They liberal government did well to rid us of the debt we'd accrued. That balances page in wikipedia shows what I can only assume is privatized and none of which is a direct effect on tax or any burden on society and required revenue generation from our government. The only time the private debt can become a problem as far as I know for direct purposes is if our government has to bail out defaulting companies who possess these borrowings. Also it's not the governments responsibility to get involved in enterprise and manage how people privately get involved in loans.
Case in point though, Australia is indirectly unable to generate credit and flush money through the market to stimulate spending. Partly because the private debt is swallowing up the investors as they have to tighten purses because they don't want to invest during a contraction phase so it doesn't matter people are spending.
Okay that's my rant sorry if it got a bit off topic I get like that. Also, just to point out I wasn't criticizing anything you said it was more expanding on what might mislead some.
Comment by Ross on 31 December 2008:
@ Kayle. Every cent of Australian private debt to foreigners is currently either being assumed as sovereign debt on the Reserve Bank balance sheet or is being guaranteed by the Australian government as term bonds get recycled or with new issues by the Australian banks with foreign lenders.
The guarantee is, at best, worth the difference between the similarly profiled CDS rates and the socialist commander in chief Glenn Steven's far lower arbitrary rate that would mortify an insurance actuary.
The Howard government lived in the same and expanded noddy land as Keating in that massive private debt/bonds not being serviced or recycled at term 100% would send us into an immediate 1890 bust and an AUD crashing to far lower levels than the 1980's banana republic rates. The "we have always run a CAD and will continue to in the future" is a stupid expectation even in absolute terms and that is before considering the current depth of this as it translates in household debt to income ratio terms, one which is far worse than the minerals boom GDP ratio based measures of national debt and far worse than the US or UK.
Comment by Greg Atkinson on 5 January 2009:
The Australian economy is a bit messy at the moment mainly because the commodities boom wallpapered over some serious cracks. Of course the good old Reserve Bank did not help things my raising rates too far when they should have been trying to grow the Australian economy so it could withstand the global slowdown. Of course the relatively high levels of household debt in Australia is a bit of a concern, a nice new flat screen TV is probably not going to help pay bills or reduce the mortgage. Nonetheless, what did the twits in Canberra urge people to do over Xmas...spend! Goodness me....
Comment by Coffee Addict on 5 January 2009:
Hi Greg. I guess that neither of our families got a new flat TV from Kevin. No baby bonus (later in the year) for my wife either. I started the year with an untimely trade (on a gold junior) and the air conditioner along with a new microwave oven expired.
Anyway, money is just money and this will be a great year for my family.
I agree that Rudd and Swan are top order geese. Encouraging people to sit in front of new TVs will not do anything for local industry (with the possible exception of cardio-vascular healthcare providers). There is a high probability that all the proposed infrastructure, education and telecomunications initiatives will be mismanaged as well. I'll leave discussion of this tangent to another day.
I don't expect the AUD to drop to 50% of the Greenback as predicted by some commentators (my view is that the Greenback will fall by at least 30% against other currencies). A low AUD will (in any case) keep more Aussies in work than a few extra dollars spent at Harvey Norman.
What's the news in Japan?
Comment by Greg Atkinson on 5 January 2009:
Hi Coffee Addict. Happy New Year. Here in Japan people are pretty gloomy about the state of the economy, mind you the Japanese are a cautious mob and so it is hard to get a handle on how bad things really are. The government here is also giving cash handouts and apparently even I will be entitled to a small payout. (about $140)
Anyway I am with you, money is money and not worth getting too worked up about. best to look after your health and keep the family smiling
Comment by Ross on 5 January 2009:
I'm not sure about the AUD, and agree re USD if this is allowed to play in a totally corrupted forex market where fundamentals are there to be trashed by regulators every time some sure play is on. But the tide will eventually get them and it will start in some obscure corner and all their funny business will tip on top of them. Here is the AUD debt refunding challenger for 09 http://www.thesheet.com.au/nl05_news_selected.php?act=2&stream=1&selkey=7651&hlc=2&hlw=