Exiled on Main Street: Implications & Realities Behind the $850 Billion Bailout

The deed is done.

Navigated in the midst of a crisis, Congress managed to pass the $700 billion Wall Street 'Bailout Plan', but only after the Senate added another $100 billion in spending packages, leaving the majority of Americans exiled on Main Street to ask, 'Where's my happy chocolates?'

And more importantly, how are we going to pay for all of this?

As the Dow continues to decline, even after the so-called 'rescue package', and Americans watch their retirement plans evaporate into thin air, less than one month before the Presidential election, the key questions Americans are asking is how did we get here and what do we do now?

Two days after the first failed vote on the bailout package, Saginaw Valley State University hosted a major forum entitled Wall Street to Main Street: What the Bailout Means.  Organized by Ken Kousky, Dow Entrepreneur in Residence at SVSU, this packed forum was perhaps the best example in recent memory of a local university assembling its resources to reach out and address imminent concerns permeating our local community.

Consisting of economics, business, and governmental professors Chris Surfield, Sam Sarkar, Jim Johnson, Jill Wetmore, Deb Bishop and Hong Park, each speaker broke the puzzle into different pieces, ranging from origins of the crisis that led to current reality, concluding with political and economic ramifications for the future.

It is my goal with this piece to summarize key components of their presentation, especially information imparted that one does not see on the nightly news or read about in the mainstream media.

Developmental Pieces of Legislation • How Did We Get Here?

At the core of our current dilemma are the notion of home ownership and the role of government in a free market society. Back in the 1940s and '50s, a home was something one did not purchase unless one could afford it.  Strict lending practices were followed and the notion of 'flipping' a home for quick profit was unheard of.

But by the 1960s, it was felt that allowing greater access to mortgage funds would grow the economy. Fannie Mae was chartered as a corporation in 1968, Freddie Mac followed a few years later, and The Community Reinvestment Act of 1977, FIRREA in 1989 and the Gramm-Bliley-Leach Act in 1999 not only allowed greater access to revenue, it lowered interest rates allowing more money to become circulated, and created publicly traded companies that changed the banking paradigm n America forever.

The CRA Act of 1977 essentially ensured equal access to funds, designed to give people 'stakes' in their communities through financial ties such as home ownership; but it also subjected banks to political pressure and encouraged them to make loans they otherwise would not.

These pieces of legislation also reduced risks to banks by allowing mortgages to be sold to the government, which increased the number of risky mortgages executed. More people sought mortgages and banks no longer made interest revenue but fee-based revenue.

FIRREA was a direct result of the Savings & Loan crisis – the precursor to today's mess – by taking the toxic stew of mortgages held by S&L's and allowing the merger of banks with savings & loans; and Gramm-Bliley was perhaps the most fatal move of all, removing restrictions on financial institution mergers and creating entities perceived to become 'too big to fail', with no oversight.

Motivated by profit, banks were willing to provide loans for housing with low or no down payments and no controls. They repackaged the mortgages and sold them to other institutions like Fannie Mae and Freddie Mac.

Easy loans, quick profits, excessive money supplied by the FED all increased demand and appreciation to housing. 25 percent and higher appreciation annually on a home was no big deal; but eventually, just like with Internet companies in the past decade, the bubble burst.

People could not afford what they bought so easily and repossessed houses led to devalued assets and no money to lend, which spread across the economy to Lehman Brothers, AIG, Washington Mutual, and a host of other companies.

Prior to the bailout the FED loaned in excess of $260 billion to provide liquidity to these companies, but it wasn't enough. Now with the bailout they've added another $800 billion, which as you will see in the next section, will in all probability still not be enough to remedy the problem.

Credit Default Swaps Take Us Into the Abyss,    But Who's At the Wheel?

Professor Jill Wetmore articulated the nature of the beast that government and the financial industry have created for us to tame in the form of a monster known as Credit Default Swaps.

"Party A pays a fixed cash flow and Party B pays a variable cash flow," she explains. "A derivative is tied to the underlying asset, so if the asset is in default Party B pays Party A the difference between the market value and the value of the obligation, or can turn the asset over to the insurance vehicle."

"What this creates is a reality where you're betting a company's bonds or other assets will default. If the seller doesn't have the money, it defaults; and with a SWAP you're betting it will default. The asset value drops, the original price is unrecoverable, and a bailout is mainly a way to find additional investors to prop up the people at the top."

"The problem with these SWAPS is that they're not regulated. They don't trade in a market; there is no price to them, and no court rulings on the record to deal with them. Individuals can trade out their positions, SWAP holders can claim the bonds & assets before the holders of the bonds, and the insurer may or may not have the assets or funds to cover the value of the asset because it doesn't think it will fail."

At this point you are probably asking yourself, 'What were they thinking'? Indeed, this is a major reason why insurance giant AIG required an $85 billion bailout.

Ironically, as I go to press, it is discovered that their executives went on a $500,000 junket within days of receiving government relief.

 Moreover, days before Congress approved the $800 billion bailout plan, the FED injected $1 trillion into the economy.

According to Wetmore, the market for Credit Default Swaps is about $45.5 trillion dollars. Yes, you heard me right.  Frightening to think that $800 billion our representatives just signed us off for will most likely be akin to throwing a pail of water on a forest fire.

The biggest players in these SWAPS are JP Morgan Chase, Citibank and Bank of America, along with hedge fund investors. When Delphi filed for bankruptcy, the CDS on its debt exceeded the value of its bonds tenfold. Locally, bank shares are drastically down as well, with National down 90 percent, Citizens Bank down 89 percent and Independent Bank down 74 percent.

Meanwhile, when it comes to Executive Compensation, professor Deb Bishop points out that in 2006 the top executives averaged $10.8 million in total compensation, 364 times the pay of the average American.

The 20 highest paid figures in the hedge fund industry collect 3,315 times more in average compensation.  Indeed, Kerry K. Killinger, the Washington Mutual CEO which the government also bailed out, collected a five-year package of $64,560,000 and Richard Fuld, Jr. of Lehman Brothers collected $354,030,000 over five years - all for accomplishing the remarkable feat of tanking their companies and bankrupting America.

A Crisis of Confidence, A Failure of Leadership – Welcome to the New Gilded Age

The great philosopher Ayn Rand once wrote that when it comes to issues of morality, there is only black & white. It's the shades of grey that are evil.

And unfortunately, on the political front, there exists a total disconnect.

Democrats are quick to blame Republicans for doubling the national debit in eight short years, but with a majority in Congress, Democrats did nothing to stop these failed practices articulated above; and in reality, encouraged people to purchase homes they could not afford as part & parcel of having a 'share' in the American Dream.

Politics is about the 'art of compromise', which as we are witnessing, is not necessarily a wise move when it comes to the industries of banking & finance.  Once they adhered to strict standards due to regulation & oversight, which is a legitimate role of government to protect the general welfare of the nation.

Today, we have become a nation of 'entitlement'.  The rich claim they are entitled to their profits, the poor claim they are entitled to homes, health insurance, and food; meanwhile, the Middle Class and the responsible entrepreneurs of small business that buy homes they can afford and pay for their own health insurance are the ones left holding the bag.

There are approximately 300 million people living in the United States and only 90 million of them pay income taxes.  Twenty years ago there were only 10 billionaires in America; today there are over 1,000. Corporate taxes account for only seven percent of the tax roles. If this bailout is costing each American approximately  $10,000, who is really paying for it?

With $250 billion spent on interest payments on the national debt alone annually, the notion of layering Universal Health Care Coverage into the mix seems a choice that has already been made by our leaders with expenditures that have already been spoken for. Of course, the FED can always print more money, but the scenario from that course of action will likely be inflation and a devaluation of our currency.

And of course, we can always escalate the tax rate on those 1000 billionaires.

Professor Hong Park, whom spoke on International ramifications that we are witnessing currently, articulated one likely scenario. "Mortgage backed securities are sold on a global scale. In the short run, foreign speculators may pull out their dollar deposits, which lead to a weakening of the dollar. In the long run, people in Saudi Arabia will buy cheap U.S. financial institutions and real estate, so as the dollar appreciates, those who bought the U.S. assets will realize significant capital gains.

Obviously, credibility needs to be re-established in America. How to go about doing that is the billion-dollar question.

We could start by seizing all the assets of golden parachute CEO's that made off like bandits with the cookie jar and earned incentives based upon a misstatement of results.

We could start by eliminating double dipping by elected officials that benefit from golden retirement plans and Cadillac health insurance policies, while claiming they work in the public interest.

We could start to eliminate the notion of a vice-president and simply let the candidate that comes in second fill the position. Philosophical gridlock has crippled Washington and largely led to this mess. In reality, Obama and McCain are not that far off the track from one another in how to deal with this crisis; and together, they would make a good team that could unite America.

We could start be embracing the notion that not all Americans are created equal – that fiscal irresponsibility, whether it be in business, or managing the budget of a home, is not something to be rewarded.

And we could start by giving homeowners that experienced devaluation of their own nest egg; yet make house payments on time each month, a bit of the bailout money to re-negotiate their own inflated mortgages.

Or we can drink, dance, and party like Nero while Rome burns.

Myself, I'm waiting for my own personal Bail Out Kit to arrive in the mail, along with a check for $10,000, a bucket to dig with, and a shovel for re-planting.