Will the last capitalist in America please turn out the lights?
How surreal. Less than ten weeks to go remain in the most entertaining presidential election campaign in recent decades. Yet right here in the United States of America, capitalism is reeling. It's under attack by a bunch of socialist bankers and the politicians whom they've purchased to represent their interests (and are themselves hoping for a nice up tick in the stock market before voters head to the polls in November).
By now you know that over the weekend the U.S. Treasury Department placed America's two largest housing lenders into conservatorship. Treasury will pump about $1 billion each into each company and get preferred equity in exchange. The government also gets warrants that would give it nearly 80% ownership of both firms. It will probably take at least another US$200 billion in new money to keep them solvent.
It's already clear, though, that U.S. taxpayers have 100% of the risk. Fannie and Freddie were too big to fail, apparently. The question now is whether this short-term nationalization will lead to the failure of any other large U.S. institutions (like the dollar or U.S. Treasury bonds). More on that in a moment.
For its part, the stock market (the global one) absolutely loved the deal. After half a trillion dollars in losses by global lenders, markets love the idea that the worst might be over. Most financials rallied. Even the U.S. dollar is stronger, which seems a bit strange considering that the U.S. government just added US$5.3 trillion in liabilities to its balance sheet.
But here is the theme resounding on the pages of today's papers: the U.S. is ahead of the curve! The U.S. has had its slower growth, weaker currency, massive housing meltdown, and lived to tell about it. Now, with Fannie and Freddie taken into Uncle Sam's bosom, America is ahead in the global game.
That's the theme anyway. It's probably true with respect to a country like Britain, whose currency continues to plummet and whose house prices won't be far behind. Yet you don't get the feeling that America's fiscal position was substantially improved by this weekend's action. The responsibility for the losses was simply transferred from a pseudo-public balance sheet to a very public balance sheet. How is that good for the dollar in the long run?
It isn't. But in the meantime, the other losers this weekend are those financial institutions who owned preferred equity in the GSEs. The common shareholders never had any rights (and the recent ones, no common sense either). But according to the FDIC and there, "while many institutions hold common or preferred shares of these two government-sponsored enterprises, a limited number of smaller institutions have holdings that are significant compared to their capital."
These smaller lenders are, ahem, screwed. The government intends to work with them on "capital restoration plans." But if you thought this event signalled the end of the losses, think again. There will be more bank failures, and they will happen soon.
What about bondholders in China and Japan? They'll be alright. We don't know exactly how it will work. But somehow we reckon those GSE bonds will end up on the Federal Reserve's balance sheet, in exchange for fresh new U.S. Treasauries (issued by the Treasury Department). In other words, we reckon the GSE bonds will be monetized.
Exactly how THIS is good for the dollar, well, you figure that one out. We can't. However, we're not going to stand in the way of a big relief rally. More on the story as it unfolds.
Out here in Colorado where the energy boom keeps on keeping on, we notice that U.S. firm Conoco Phillips has offered US$8 billon for half of Origin Energy's coal-seam-gas assets in Queensland. Good on ya, Conoco!
We may not have finanicials to kick around anymore, but we'll always have energy as a secular investment theme. We hope Conoco had some back-channel conversations with the Queensland government about the futures of CSM before it ponied up its cash. But Conoco may just be trying to get rid of spare cash before it's stolen away in a windfall oil tax scheme by the next U.S. administration. Either way, from uranium to coal to LNG, it's a good time to be an energy invnestor in Australian projects.
You editor will do his best to stay in contact this week before leaving for Sydney on Thursday. We arrive Sunday for a mining show at the Hilton. But in the last week, we spent four days in Annapolis, Maryland with about 80 of our global publishing colleagues.
The Agora publishing family is truly global now, and it was good to hear how others are faring in such a tough market. Mainly, we wanted to know what sentiment was like in other markets and what customers were expecting in today's very competitive market.
About the only upbeat folks was the team from India. They are as excited as can be over what's ahead. They managed to get us excited too! India shares at least one quality with Australia (in investment terms): there are more good stocks than there are analaysts to tip them. That's precsiely the kind of advantage you want as an independent investor willing to do your own research.
By the way, it would be hard to see the Fannie and Freddie nationalisation as anything other than a massive official back-pedal from the free market. Maybe we are entering a new era of less free trade, higher taxes, and more nationalisations. The government backlash against globalisation could last for awhile. Capitalism is in retreat. Hmmmn.
Dan Denning
for The Daily Reckoning Australia
P.S. to get The Daily Reckoning direct to your inbox sign up to our free e-mail newsletter or if you prefer to use RSS, subscribe to the Daily Reckoning RSS feed.
Related Articles:
- Fannie and Freddie in a Free Market Economy
- Two More Reasons to Sell Treasury Bonds
- Fannie and Freddie Say Goodbye to Veto
- Fannie and Freddie are Finito
- Fannie and Freddie: Playing With a Stacked Deck
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 watcher7 on 9 September 2008:
Capitalism's Reality Check
E. J. Dionne Jr., washingtonost.com, July 11, 2008:
“The biggest political story of 2008 is getting little coverage. It involves the collapse of assumptions that have dominated our economic debate for three decades.
“Since the Reagan years, free-market cliches have passed for sophisticated economic analysis. But in the current crisis, these ideas are falling, one by one, as even conservatives recognize that capitalism is ailing.
“You know the talking points: Regulation is the problem and deregulation is the solution. The distribution of income and wealth doesn't matter. Providing incentives for the investors of capital to "grow the pie" is the only policy that counts. Free trade produces well-distributed economic growth, and any dissent from this orthodoxy is "protectionism"...
“This is the third time in 100 years that support for taken-for-granted economic ideas has crumbled. The Great Depression discredited the radical laissez-faire doctrines of the Coolidge era. Stagflation in the 1970s and early '80s undermined New Deal ideas and called forth a rebirth of radical free-market notions. What's becoming the Panic of 2008 will mean an end to the latest Capital Rules era.”
“The advent of ‘free trade’ as the prevailing ethos coincided with an economic boom, lasting from the early 1850s to the early 1870s. Contemporaries saw the first as causing the second; economic historians have been more sceptical. The removal of tariff barriers probably had only a marginal impact on the British economy, but the ascendancy of ‘free trade’, in its larger sense of national commitment to economic progress, was closely related to an entrepreneurial enthusiasm which all classes seemed to have shared... The free-trade movement accompanied rather than anticipated the commitment of the British economy to manufacturing, transport, and service industries with an urban base...” (Kenneth O. Morgan, editor, “The Oxford History of Britain”, Revised Edition, (Oxford, Oxford University Press, 1999), pp.528,520).
“The period 1892-1914 raises some difficult problems for liberal theories of foreign trade. The evolution of the European economy reveals a disturbing correlation. Grossly oversimplified this can be expressed in the following equations: protectionism = economic growth and expansion of trade; liberalism = stagnation in both... the return to protectionist trade policies undoubtedly coincided with a considerable change in the main economic trend, leading to a period of growth unprecedented in European history... foreign trade in the protectionist countries grew more rapidly than in the liberal countries...” (Paul Bairoch, “European trade policy, 1815-1914”, The Cambridge Economic History of Europe, Vol.8, The Industrial Economies: The Development of Economic and Social Policies, (Cambridge, Cambridge University Press, 1989, p.69-70).
Comment by Mireille on 10 September 2008:
I agree with watcher 7. Also, what is this magical theory where you can print good paper after bad and start the game all over again. PAPER backed securities, secured by paper backed securities secured by PAPER?
Pingback by Is the US Ahead of the Pack in Economic Recovery? on 4 November 2008:
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