Fannie and Freddie, and the Bailout Around the Corner
Any day now -- perhaps any hour -- the plug will be pulled on Fannie Mae and Freddie Mac, and a massive government bailout will ensue. Together, they'll become the largest government-owned entities in American history, and, once again, taxpayers will pay the bill, which could come to $25 billion or more.
One question is how did we ever get to this? The Savings and Loan Bailout of the late 1980s should have taught us that when government guarantees the downside of risks and private investors reap the upside gains, there's hell to pay. The risks Fannie and Freddie took on weren't officially guaranteed by the government -- that is, by you and me -- but investors assumed they were. And so did Fannie's and Freddie's executives, who reaped a bonanza with bonuses in the tens of millions each year.
Apologists will say that Fannie and Freddie exist to make housing loans to low-income Americans, so it was inevitable that the two giants would get caught in the quagmire of the housing burst. But the fact is, Fannie and Freddie -- and the executives who ran them and still run them -- have been out to maximize profits. Period. Just the same as every other mortgage and investment bank. High-risk sub-prime loans offered a higher rate of return, so Fannie and Freddie went into them big time. And because of the implicit government guarantee, Fannie and Freddie could take on even more risks and make even more money. Until now.
It's another case of socialized capitalism, folks. The largest, yet. Along with making lots of money for investors and their executives, Fannie and Freddie corrupted our political process. They blocked any attempt to reign in the risks. Their lobbyists were and are the most sophisticated and among the most ubiquitous in Washington.
What to do now? Hope that, like the S&L fiasco, taxpayers can get back a fair portion of our dollars. But unlike the S&L fiasco, this time we should make sure we bury socialized capitalism for good.
One question is how did we ever get to this? The Savings and Loan Bailout of the late 1980s should have taught us that when government guarantees the downside of risks and private investors reap the upside gains, there's hell to pay. The risks Fannie and Freddie took on weren't officially guaranteed by the government -- that is, by you and me -- but investors assumed they were. And so did Fannie's and Freddie's executives, who reaped a bonanza with bonuses in the tens of millions each year.
Apologists will say that Fannie and Freddie exist to make housing loans to low-income Americans, so it was inevitable that the two giants would get caught in the quagmire of the housing burst. But the fact is, Fannie and Freddie -- and the executives who ran them and still run them -- have been out to maximize profits. Period. Just the same as every other mortgage and investment bank. High-risk sub-prime loans offered a higher rate of return, so Fannie and Freddie went into them big time. And because of the implicit government guarantee, Fannie and Freddie could take on even more risks and make even more money. Until now.
It's another case of socialized capitalism, folks. The largest, yet. Along with making lots of money for investors and their executives, Fannie and Freddie corrupted our political process. They blocked any attempt to reign in the risks. Their lobbyists were and are the most sophisticated and among the most ubiquitous in Washington.
What to do now? Hope that, like the S&L fiasco, taxpayers can get back a fair portion of our dollars. But unlike the S&L fiasco, this time we should make sure we bury socialized capitalism for good.
posted by Robert Reich | 4:06 PM
47 Comments:
The Federal Reserve claims that if this happens, they will go bankrupt?
It is interesting thatRepublicans and the corporate elite begrudge the American people National Health, More school programs, regulations to insure better working conditions etc. minimum wage, social security, etc. and want everyone to pay trillions for their free enterprise capitalist flops in Iraq and at home. The war on terror was actually a war on the American social system which is collapsing all around us at the cost of trillions. who needs terrorists when we have Wall Street running amuk and George Bush and this congress? Thank you George Bush.
If the government bails Fannie and Fredie out, doesn't that mean that the entire banking system abroad will take a terrible hit. Doesn't this mean that a greater depression is right around the corner? And, does it not mean that a great depression will send shock waves to the rest of the world?
How's this for a complication to a bailout:
"Aug. 22 (Bloomberg) -- A failure of U.S. mortgage finance companies Fannie Mae and Freddie Mac could be a catastrophe for the global financial system, said Yu Yongding, a former adviser to China's central bank.
``If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic,'' Yu said in e-mailed answers to questions yesterday. ``If it is not the end of the world, it is the end of the current international financial system.''
China's $376 billion of long-term U.S. agency debt is mostly in Fannie and Freddie assets, according to James McCormack, head of Asian sovereign ratings at Fitch Ratings Ltd. in Hong Kong."
http://www.bloomberg.com/apps/news?pid=20601080&sid=aslo2E01QVFI&refer=asia
S&L bailout - Keating five - Fannie and Freddie - Senator McCain - Greenspan's book. This stuff should be writing itself.
Dear Mr. Reich, Forgive me for going off topic but I felt compelled to comment on your tremendous performance tonight on CNBC's Kudlow and Company. When you ended the hour by pointing out in clear and definite terms the misinformation campaign going on about Obama's tax policies, and used the term "swiftboating", and directly addressed the other three speakers, it was dead on. Then you followed it up with data and a nod the the Tax Policy Institute, well I must say, sir, that you very much impressed me. Thank you so much for the work that you do.
"High-risk sub-prime loans offered a higher rate of return, so Fannie and Freddie went into them big time."
"Subprime loans" are, by definition, loans that don't meet Fannie and Freddie's guidelines, so it's more than a little misleading to say that F&F "went into [subprime loans] big time." You don't need to distort the facts to make F&F look bad.
Prof. Reich --
Thank you for the intelligent commentary.
Apparently, there is some move afoot to avoid devaluing the preferred stock of Fannie and Freddie during the bail-out. In the 230 year history of the Republic, have U.S. taxpayer dollars ever been handed directly to a private corporation so that it could pay dividends?
Liberals like yourself think Fannie and Freddie should have been nationalized long ago. Conservatives like myself think they should have been broken up. But I think we can agree that no private institution should ever be allowed to be "too big to fail".
Whatever happened to the Republican party I once supported? (Or did it ever really exist?)
This bail-out is outrageous. But where is the outrage?
Right, F&F didn't go into high risk subprime loans.
They went into high risk subp[rime loan packages.
The wrapping makes all the difference.
And by buying in bulk, they saved money...
Apologists will say that Fannie and Freddie exist to make housing loans to low-income Americans
That's patently false, of course - unless you think "low income Americans" can afford $400,000 houses - or the new, raised cap of $600,000?
Actually, apologists typically say that they exist to make housing affordable to low income Americans, by creating a market for securitized mortgages.
In this, they have provably failed, since their existence, and the existence of the money they supplied, helped to drive up the price of homes into the biggest property bubble, the biggest asset bubble, in written history.
It would be nice if more trained economists made this connection. It's a simple concept - increase the supply of money, and you'll make prices go up. Increase it by alot, and they go up a lot.
Jim, in sciences, you make observations, then try to create theories to explain them.
In economics it's often the case that you invent a theory, then look for data that supports it, while discarding data that doesn't.
Just look at Sbvor's selective use of data and the way he tries to twist it, to fit his preconceived conclusions.
This is how it's done.
Is the taxpayer risk here really "$25 billion or more" As Mr. Reich states? I was under the impression that the amount at risk in the Big Macs' portfolios was many times this.
Anybody got a clarification, explication or source for the number?
Who knew Chavez and Bush have so much in common?
Coming up next. GM asking for their hand out. (loan backing to retool their line)
Then Lehman brother and Lynch.
uhh... lovely. Make that $700Billion deficit for 2009.
I for one think we should nationalized Exxon and Chevron. Chavez is smarter than Bush in that regard. He actually make the country richer instead of using public money to bail out rich friends.
OK, correction. US is not socialized capitalism.
It's CLEPTOCRACY capitalism.
rein
This is another fine mess those Republican voters have gotten us into. When are regulators going to start working for the American people instead of the Republican Party? When there is no policeman on the beat the greatest beneficiary is not the taxpayer who is relieved of the cost of maintaining that police officer, but the thief.
Dr. Reich,
When Freddie Mac announced a writedown of over $800 million, 4 times higher than expected, and Fannie Mae $1.2 billion, also 3-4 times higher than expected, the hand writing was on the wall for a taxpayer bailout and maybe liquidation.
Meanwhile, just before these expanded writedowns were announced, Henry Paulson was saying the worst is by. Goes to show you how poorly our government officials are informed and managing the money system.
One of the bailout options is to inject taxpayer cash in exchange for preferred shares in both companies. These shares would take precedence over the rights of common shareholders in the payment of dividends and if the companies had to be liquidated.
More bad news on the horizon is that Fannie and Freddie have a huge amount of subordinated debt
($19 billion) that ranks below other bonds in the firms' capital structures. This debt qualifies as "Capital" if the firms' Core Capital meets certain conditions. Here's the catch: interest payments on the subordinated bonds may have to stop in the event of a bailout, meaning the bonds would be in default, according to legal contract requirements.
This would then trigger the necessity for payments on credit insurance that has been written for those who have bought protection on Fannie and Freddie's subordinated debt in the event of a default. Noone knows how much credit insurance has been written and whether those who wrote it have enough money to make the insurance payments.
So the multiple costly effects of a bailout are pretty complex and serious. In a bailout, the buyers of credit insurance most probably will be forced to accept large discounts, thus receiving much less than they are owed on the credit insurance they purchased ... all causing unknown further major losses connected to the Fannie/Freddie fiasco.
Hold onto your seatbelts as our government will likely be forced to print more bailout money far in excess of the $25 billion you mention, Dr. Reich.
Only satisfaction is that common shareholders will get their due reward of NUL for supporting semi-government financial institutions (i.e., the implicit government and thus taxpayer guarantees of Fannie/Freddie mortgage transactions)carried away with the profit greed factor in mortgage lending and runaway CEO salaries.
Remember, these two firms hold almost 50% of all US mortgages and have packaged and sold many of them to investors abroad as well.
Moreover, the two firms are extremely overleveraged caused by their getting caught up in the sub-prime fever and leaning on that "Implicit" government (taxpayer) guarantee.
The repercussions can be quite drastic so our government has to get this financial time bomb under control or else...??
Next step would be for much needed Transparency so all the implications of a default on the debt are on the table. Let's not catch the historical Japanese "hidden from view sickness" concerning the inner workings of their financial crash 12 years ago ... which ultimately dragged their crisis on for many years, making matters 10 times worse for their entire economy.
Let's get real, "which could come to $25 billion or more". Kind of like the Iraq war that was supposed to cost $30 billion and stands now near $1 trillion. The GSEs hold about $5 trillion in loans. A 10% decline in the value of their portfolio seems to be on the conservative side. So I would say the bailout would cost taxpayers around $500 billion, about 20 times the projected numbers.
I say let those pigs die. (Same goes for Ford and GM). So foreigners won't lend us anymore money? Excellent! We finally have to live within our means. Nothing wrong with that.
All the GSEs did was flood the market with cheap money which in turn drove up the cost of housing for everybody. We'll be much better of if government would get out of the credit business and stay out of it. That also includes Sallie Mae which managed to push the cost of tution beyond the reach of normal middle class Americans. Once a (college) education becomes unaffordable for the majority the country is in serious trouble. We're already there.
Can you please add a bit of history? Why was Fredie started?
Anonymous,
If you want a good summary of Fannie Mae and Freddie Mac's history, suggest you Google article by bright University student by the name of Rob Alford. The article is entitled:
"What are the Origins of Freddie Mac and Fannie Mae?"
Hope this addresses question you are asking. If not, please explain more succinctly what historical data you want.
Robert said...
"It's another case of socialized capitalism, folks. The largest, yet. Along with making lots of money for investors and their executives, Fannie and Freddie corrupted our political process. They blocked any attempt to reign in the risks. Their lobbyists were and are the most sophisticated and among the most ubiquitous in Washington."
Amen. Well-said. Nationalize them and turn the management and administration over to those who are committed to public service and not the pursuit of profit. Much like Michelle Obama was talking about last night in her speech where she lauded those who reject Wall Street and instead choose lives serving the public good.
btw: a softer Mrs. Obama will be far more effective in making the case for BO than her sharply critical and biting policy speeches. Too many voters just aren't ready for a first lady that doesn't appear somewhat warm and fuzzy. BO is going to need every vote he can get in several of the swing/more independent leaning states.
Our capitalistic system needs to protect itself from the republican motto of "corporate greed at any cost".
We need shareholders rights and corporate governance movements to protect capitalism.
Corporate management does not own the corporations, shareholders do, but shareholders have no collective voice.
State pension plans and attorneys generals need to use their power and influence to begin force change.
Our federal government is strapped by lobby efforts and bipartisan bickering. They will never agree on legislature.
We need shareholders to grab the reigns of their companies and force management accountability.
We have seen states suing large investment banks to recapture losses from illegal selling practices.
We need large shareholders (pools of capital like state pensions, insurance companies, etc.0 to begin to vote their shares and change management compensation and independent accounting reviews to ensure a balance and long-term viability for companies.
Investor confidence is the backbone of capitalism and many shareholders that believed in a fair and honest system have been burned.
I fully agree with the the last comment by anonymous that shareholders should force management ccountability. Why do we always blame the government when more than 50% of us actually don't even bother to go and vote? This is the most suicidal statistic I have ever come across. We are the BOSSES, we keep politicians in office and we don't care who gets in there?
How many of us know who is our Congressman or our Senator?
How about our Mayor?
Clueless, right?
Anyway, to get back to the comment by anonymous, millions of us are shareholders, we receive in the mail all sorts of voting documents and what do we do? We shred them.
However, since we have reached such a dangerous point, I see no other option than governmental bail out because if that does not happen, the chain side effects will hurt, and hurt terribly, many more of us.
Notsovast, Anonymous:
Agree wholeheartedly with spirit of your comments.
Would only add the relationships, legal and otherwise, among Corporate Management, Board of Directors and Shareholders of many US firms have become so distorted, manipulative, and unprofessionally objective, that this is a mine field for lawyers and appropriate authorities to do good future work on.
It's why, among other reasons, Corporate Raiders for so long have been having a field day in America exploiting the broken down systems of accountability, management performance and conflicts of interest in US corporations. Such situations often become foul-fodder for the destructive practices of the "Take-Over Angels" who are inclined to exercise their brutal short-term profit vengence out on the vulnerable victim firm's loyal, hardworking employees.
Hate to say it, but again this is another area mature Europe countries have developed over the years much better Oversight,and legally effective regulations/penalties especially to protect Employees as well as Shareholders from unscrupulous acts by Corporate Management and/or Boards of Directors ... or to protect Corporate Management from poison dart Takeovers or manipulations by a Board of Directors.
There is no chance of getting rid of "socialized capitalism", it's the only type we have. Firms like Boeing or Lockheed Martin wouldn't exist if they weren't kept afloat by sweetheart government contracts.
High cost extraction industries like north slope oil, tar sands, deep sea drilling couldn't compete with cheap mideast oil if it wasn't for depletion allowances and tax breaks.
The same goes for the nuclear power industry and the ethanol from corn effort.
A firm that isn't part of socialized capitalism is a corner bodega. Anything bigger is getting government favors.
If Robert Reich wants to change the system he is going to have to explain where he is going to find the political power to pull these firms off from the government teat.
Ain't gonna happen.
Consiprists (including Dr. Reich):
Fannie and Freddie were only allowed to purchase conforming debt. Sub-prime, Alt-A, and other non-conforming products were and are expressly prohibited from being in the Fannie/Freddie portfolios.
The write downs at Fannie/Freddie are the direct result of an asset bubble bursting and the associated mark to market accounting impact.
Blaming Fannie/Freddie for this result is nothing more than rampant conspiracy theory. To believe that Freddie/Fannie are culpable for an asset bubble burst is to believe that they led a vast network of banks and real estate appraisers in a massive run up of home prices only to have their scheme fall apart in the end.
It's just too implausible to believe and I fail to understand why we must demonize a few when the causes are so widespread. There was an abundance of credit available and a variety of new loan products created. Many of these new loan products were just plain crazy--negative amortizing, 125% LTV, fixed interest only, etc., etc., etc. Fannie/Freddie created none of these things and did not participate in the equity markets for them.
Fannie and Freddie exist to provide liquidity for the market for conforming mortgage backed securities, which have historically been very safe investments. So, I don't think it's fair to characterize the source of Fannie/Freddie's troubles as something entirely of their own making.
We can, however, debate whether or not Fannie/Freddie should have been better stewards of the assets they were purchasing. For example, they could have taken steps to question real estate values, the merits of relative valuation in an extreme inflationary environment, and generally better assess the riskiness of the underlying assets. In short, there is a large and robust laundry list of things they could have done to try and head this off. Although, to be fair, the end result still may have been the same.
Their executives were well compensated during this time; perhaps inappropriately so. But that is neither here nor there when it comes to the current situation.
The proposal, unless I'm failing to understand the financing, is that the tax payer will bailout the debt holders (because the triggering of debt covenants is what will cause a bankruptcy) and receive convertible preferred shares in return for the capital infusion. The U.S. government would then be inline to receive prefered dividends and to convert its preferred equity into common equity at a given strike price (generally at a tidy profit).
The debt holders, including foreign entities, under this proposal walk away whole or nearly so, which is important for the stability of the international financial and banking system. The shareholder (or, as many in this blog like to think of them, obscenely rich guys who don't deserve such largess anyway)gets screwed in this one because the convertible preferred shares dilute their worth down to almost nothing. This conservative says c'est la vie to that one because losing it all on an equity bet is a risk you must accept when putting money into a stock to begin with.
So, who wants to have a discussion about what actions Freddie/Fannie could have taken to be better portfolio stewards? That is the real discussion here because the past is prologue and all we can do now is try and learn from it and hopefully avoid similar mistakes in the future.
Anonymous Matt
Robert Feinman,
Some weeks ago I described to Dr. Reich deep water oil/gas drilling techniques using Drill Ships and Floating Production systems (that save the long-lead construction of costly platforms and long pipelines) and of the importance US government takes a 50% ownership in promising offshore sites ... or enters a Royalty fee arrangement that is based on the inherent value of a particular find. The current lease arrangements are a fool's give-away to the oil firms.
Just last week, I heard Mrs. Pelosi say the Democrats are willing to consider offering more offshore drilling acreage in very promising areas in exchange for appropriate Royalty deal with oil/gas development firms,(among other conditions) or a variation
of the well-known excellent NORWAY model of shared profits in offshore oil/gas finds.
So, there's hope our government can become more Capitalistic in its deals involving such scarce resources in the interests of all US taxpayers. My last repeat detailed writing on this subject was posted to Dr. Reich's essay "Questions and Answers on What to Do About Oil and Energy."
Pelosi's recent more commercial business aprroach on this matter gives me some hope. The oil firm's can handle the costs of deep water drilling in shared profit arrangements, from someone who was in this field for some years in Europe when significant North Sea discoveries were prolific in the
70s.
robert D. Feinman:
Under our so called capitalist democracy, reform is impossible in certain areas like what you speak of and elections...Getting Politicians and their sponsors to do the right thing is essentially committing suicide or hari-kari for half of them. It will never happen. Can never happen. We the people are essentially their goose that lays golden eggs for them.This is why this system must be condemned by all of us. There is no hope. When the republicans regain power, they will essentially destroy any progress...Now, of course, the democrats are doing the same thing. There is just no hope.
Matt:
Welcome back!
Not sure you're right on about Freddie/Fannie and subprimes. Appears in July, 2007 they, combined, held about $168 billion in securities backed by subprime mortgages. It has been my understanding no one really knew the details behind what made up these mortgage backed securities packages. Seems part of the problem for the whole finanicial industry in getting a handle on the extent of their exposures.
In addition they were extremely overleveraged. Their debt to equity ratios were astronomical. Would agree "conspiracy" might be too strong but "gross mismanagement" might be too weak.
Their executives were well compensated during this time; perhaps inappropriately so.
"Inappropriately" also seems a weak descriptor. Running a corporation with an "implicit" government guarantee, giving them much easier access to more debt to fund more assets to create more profits would beg for limits to executive compensation. They were operating an enterprise with an extreme advantage in securing debt. Didn't require a rocket scientist to make profits in that environment short of the bottom falling out of the whole market. Surprise, surprise!
The solutions? Either get the government out of the enterprise supporting business or impose rigid controls and limitations and oversight on liquidity, debt to equity ratios, investment portfolios. Perhaps an internal audit staff reporting directly to the Congress. More accountants can't be a bad thing. ;)
Art:
You know, I just can't stay away..
"Seems part of the problem for the whole finanicial industry in getting a handle on the extent of their exposures."
Sounds like a controls issue. Definitely agree that auditors might be a good thing.
Art:
You raise an interesting point with the debt/equity comment. You're right, by the way, they were obscenely high.
Modigliani and Miller tell us that a company should be indifferent between funding assets with equity or debt in a tax free environment. The challenge is that we don't live in a tax free environment and debt has its advantages vis-a-vis net income, cash flow and ROE (or ROIC or RONA, etc.)
Mssrs. Fannie and Freddie were, in retrospect, clearly irresponsible with their capital structure and the lack of clarity around portfolio risk is troubleing. But you can hardly blame management for making decisions when they felt like (rightly, wrongly or deceptively) they had a nearly bullet proof portfolio of assets.
You and have debated and, I think, agree to disagree about what corporate tax rates should be. But I think it might be reasonable and rational to consider corporate tax structure, the treatment of interest expense, etc. so as not to incent the kind of decision that leads to highly levered balance sheets with the tax code. One must assume that there would be a way to keep it revenue neutral while adjusting out the incentive for leverage.
I think you're also right when it comes to a quasi- or actually-backed entity. There has to be strict oversight and appropriate controls.
AM
P.S. whoever said that GM is next in line...
1) GM is not too big to fail. This might have been true 50 years ago, but it isn't the case today.
2) Labor unions are as much to blame as management for the current mess that was once the jewel of American enterprise.
So, I say let it die if it is going to (though I'm not sure it is). Many here will surely bemoan the loss of jobs and talk about how a more protectionist posture would have saved the company from being outcompeted by Honda, Toyota, et. al.
Don't forget, though, that Honda builds Accords and Civics in Ohio and the ubiquitous (at least in my neighborhood) Odyssey in Alabama. Toyota builds the Camry and Avalon in Kentucky and its trucks in Alabama and Texas.
It's not populist and partisan to talk about those jobs, though.
"Subprime loans" are, by definition, loans that don't meet Fannie and Freddie's guidelines, so it's more than a little misleading to say that F&F "went into [subprime loans] big time." You don't need to distort the facts to make F&F look bad."
Please get your facts before you pop off, Fannie and Freddie bought tons of subprime on the open market from 2003 thru 2006, no they didn't generate that business but purchased the bonds in order to grow their business. Don't you remember how they coun't come up with any financial accounting for a few years? Basically they became a hedge fund for all intent and purposes.
The issue with Fannie and Freddie is basic to the new world order of financial engineering. That is the creation of credit without capital to back it up but instead use AAA rating, derviative contracts, structured credit vehicles to leverage a small amount of capital into a very large debt, all based on the idea that American homes would continue to appreciate in price over time, that default rates would stay low.
The world wide saving glut that was discussed so much was in fact an illusion of this financial engineering.
What we are left with today is highly leveraged financial banks world wide that instead of having capital have credit instruments or structured credit products that are in fact worthless but carry a value on the bank's books. Since they actually don't have the real dollars they are suppose to have to carry their debt loads, they are in fact broke. The FED and other central banks are keeping the bank doors open via various bailouts but the result will be a period of defaults, BK, and rising capital by the world wide banking industry. The result will be a vastly different slower growth world economy for the next 10 years at least and for the american consumer the debt party is over.
Matt,
I too would like to join Art Layman in welcoming you back on this blog with your crisp solutions-oriented remarks ... an approach I share.
Matt:
Not familiar with "Modigliani and Miller", my business readings predated yours by a few years, and though I would accept their premise theoretically I don't know that I agree completely in reality. Debt comes with payback schedules (cash flow) and a variety of encumberances depending on the financial strength of the borrower.
No doubt as long as interest payments are tax deductible this adds to the leverage of using debt, although leveraging could still be attractive even without taxes with a decent IRR and relatively low interest rates. On the other hand debt can appear to management as an easy out; a financing mechanism unfettered by pesky new stockholders holding their feet to the fire. Leveraging in this analysis provides the perfect rationale for more debt, earning ever greater profits. Until you're leveraged right into bankruptcy.
Executives in many American companies are poor risk managers. They tend toward very short windows of forecasting and are often optimistic about those short windows. In troubling or growing times, debt seems to them the least cumbersome method of financing growth or cash flow stability. Granted in troubling times additional equity may not be readily available but I have known many companies, and worked for some of them, who would acquire more and more debt to stay afloat when the real answer was to cave and cut losses.
To your point, debt also comes with the burden of creditors being able to force bankruptcy, if defaulting on loans. Equity seldom has that option. If we could count on management to always limit debt to a reasonable, managable amount that would be one thing but to far too many it becomes manna from heaven and abuse becomes an impediment to future expansion, to say nothing of existence.
I would admit too that increases in equity, for public companies, come with enormous upfront costs, often ignored, and the total cost of debt, successfully concluded, may be far less. That does not negate debt as a slippery slope.
...But you can hardly blame management for making decisions when they felt like (rightly, wrongly or deceptively) they had a nearly bullet proof portfolio of assets.
Understand your judgment based on your perspective, but I can certainly blame management. They knew better than anyone that the guarantee was "implicit" not explicit. Good management would have dictated not pushing the envelope too far, at least without getting assurances from Congress that all would be protected. Essentially they undertook risks, stupid risks, with little regard for the stockholders, while knowing that debtholders were probably secured. One cannot ignore the earnings the executives received for following this course and the chicken and egg question comes to the fore. What was the true motivation for taking on this level of risk?
Per above, even if interest deductions were disallowed, something being considered by many, leverage would be dampened as a financial tool but could still be attractive to companies with easy access to debt. It is a complex issue but this emphasis on significant year over year growth, driven principally by Wall Street, causes many execs and boards to make decisions not necessarily in the best interest of long term stockholders.
I am a romantic and purist when it comes to business. I am far more enamored with a steady, strong, continually profitable company, even with slow stock price appreciation, than one which skyrockets profit growth for its "hour upon the stage, and then is heard no more".
Stockholders are important but companies are made up of employees and they exist in communities. Thus I don't accept the age old premise that stockholder welfare should be their paramount objective. Stockholders run the risk of losing a few bucks, and if they are smart investors it will only be a few bucks. Failed, merged or relocating companies can devastate many lives and many of those did not enter into the contract with the level of risk knowledge that the investor has.
Always marvel at the whining over Sarbanes-Oxley, which, though cumbersome, in net is nothing more than trying to put internal controls back in place in public companies.
Art:
You're right about Sarbox. It wasn't a big deal to implement in the company I worked in at the time because we were already doing most of it anyway. I am told that it was a much bigger deal at my present employer.
I'm also a slow and steady business romantic, but, by virtue of my role, see the other side far too often. Not sure we've ever been specific, but I am the VP over planning, business development (M&A) and investor relations here.
I am presently in the middle of a rather heated conversation with my superiors about whether or not we should be concerned about how different our internal estimates of business performance are from what the street is modeling. (this is for next year and while the net is about the same, the timing is very different).
I am arguing that analysts really aren't paying attention to those pieces of their models yet and that because the net is good, then we are good. They want me to force through some unnatural actions to align expenses and bring the down quarters up (but not the up quarters down).
I've got my team running ragged to prove that the current timing assumptions of analysts are not vetted so that I can avoid squeezing when we ought not to.
Good times.
Art:
Modigliani and Miller's theorm can be found here...
http://en.wikipedia.org/wiki/Modigliani-Miller_theorem
Pretty interesting reading for your average finance geek.
Matt:
The crux of my corporate America issues. We've got analysts on Wall Street that wouldn't recognize a business if it did not mirror one of their business school case studies and yet they are putting corporate execs through hoops because they set the forecasts and the expected performance.
Maddening!!!!
Matt:
"They set" being the analysts.
Matt:
BTW, nice title. My biggest regret was that I never got deep into M&A. Always thought it looked like a fascinating field.
You can have Investor Relations, thank you. ;)
Keep in mind that while a Van Gogh is worth millions today, your forecasts a couple of years from now won't be worth the paper they are written on.
Would really like to see some execs tell Wall Street that these are the numbers and how I see them flowing. To hell with your estimates!
Art:
LOL. You nail my frustration today.
The thing I really want to say, is "who F***ing cares?" This isn't important.
My buddy, the vp of strategy here (who I carpooled with today), just had to take my car and head home because his daughter was rushed to the ER (she is apparently fine, but they are testing). That's important.
AM
Matt:
Concur totally, health, especially kids health, is most important. All the rest is BS.
Keep in mind though that miss your quarter bottom line, plus or minus, and Wall Street might downgrade their recommendation.
Wall Street thinks they're Mother Nature and they don't like to be fooled. It is of no matter that the miss was based on their numbers not yours. Those guys make far too much money to ever be wrong.
I have often told my accounting staffs that what we do and the accuracy of it is very important and we should always be striving for perfection but there are people starving in this world and that's a problem, what we deal with are opportunities.
Hope everything is well for your buddy's daughter.
Given the offshoring of middle class jobs to India and China, I would like to see someone confront Alan Greenspan with the monthly jobs creation numbers announced by George W Bush and dimwit US Labor Secretary Elaine Chao. They rarely meet the target of 100K-130K new jobs created per month, the number needed to absorb new graduates.
If your job has gone offshore, it's not coming back and it's not being replaced. The difference in lifestyle probably goes onto a credit card.
I know Alan Greenspan, in his book, Age of Turbulence states "labor specialization." American jobs will move to registered nurse, anesthetist, xray tech, sports therapist, physical therapist, respiratory therapist and the gamut. But can someone please corner Alan and ask how to pay for the transition? and ask how mortgage payments could reset to a higher monthly payment? Stipulate his reply has to be in one syllable words, either his own or Andrea Mitchell has to translate for him; she's a journalist.
Someone on a blog stated the Fed powers that be will be immune from any fallout from the housing bust. My thought is let the banks collapse. Let the people who work at the banks find real jobs, especially those stipulated by Alan Greenspan.
Art:
Buddy's daughter is fine. I brought them some takeout at the hospital last night (we live about three blocks from each other). Turns out that his 13 year old daughter went to the nurse office at her middle school complaining of some chest pain. The nurse says, "gee, I hope it's not a heart attack." The daughter immediately starts hyperventilating. Her Mom shows up and the daughter is on a stretcher and receiving oxygen. Ambulance leaves for the hospital...tests...turns out she pulled a muscle that is between the ribs...probably during sports practice. All is well that ends well, but scary nonetheless.
Matt:
Good news! Certainly is scary though. Perhaps the scariest thing is that a nurse would utter "heart attack" to a child of that age. The odds against are so extreme that even though precautionary measures should be employed best if she kept her mouth shut. Nurses are not generally diagnosticians.
Doctor's seldom hypothesize with patients until they have better evidence. My doctor felt what he thought was an aortic aneurysm and suggested we do an ultrasound to see what was causing my mild abdominal pain. Only after the ultrasound results did he tell me that he suspected an aneurysm and he was right.
Medical folks are wonderful people but speculation is best left to experts when the time is right. Even we accountants know that repsonses to auditors are best left to management.
Maybe its time to have socialized banking for the average citizen and private banking for businesses. The average folks can deposit their money safely (hopefully) and borrow it for mortgages, auto loans, etc. if they meet all underwriting guidelines. The average folks need a simple and safe place to put their money. Let the wealthy put their money in a separate system and eat each other alive if they are not careful. No bailouts. Who cares if the Chinese banks lose their money? They knew there was risk involved.
Should The US government bail out American corporations?
Does corporate America share its profits with the tax payers? The answer is absolutely not.
Do they share the profits with the tax payers? The executives are paid millions.
The US Government should bail out all corporations large and small is that right? The answer is no. If it is a viable business, they can raise the money from investors, if not, let them close shop.
If the government decides to bail them out if should be at a cost (like shares in the company) where the government will make money and have a say in running the company. Even better have a public referendum where the voters decide.
Carmakers want money from the government; the financial institutions want money - where does it stop.
It is about time corporate America should learn they have to stand on their own feet. Where is corporate America financial responsibility?
They claim the government is abusing its financial responsibility; it seems Corporate America is no better. They also go to their workers to take a pay cut, is that fair? It seems the little guys are the ones that always pay the price for corporate financial abuse and miss-management.
Other corporations in the world are not asking to be bailed out - they go out of business.
Jay Draiman
Here's another stab at the accepted ideology that often slips by without question. Fannie and Freddie never, even in their earliest days made housing more affordable. To the contrary, they made housing less affordable. As messed up as our system is and was, anytime you add money or capital to a market, in this case the housing market, you decrease supply and increase demand and pricing. That is exactly what Fannie and Freddie did, add money buy buying mortgages, enabling banks to sell more mortgages. It is very similar to the mortgage interest deduction on our federal taxes. We are allowed to deduct the interest we pay on our mortgages, first and second houses, if unlike McCain, you can remember how many house you have, from our total income. This might seem like it helps us afford housing, but it actually pushes housing prices up and disadvantages folks who have high equity in their homes and owe little interest. When you walk into the bank for your home loan, the bank automatically takes your future interest deduction into account and qualifies you for a larger mortgage because of that. When you spend that extra amount on a nicer house, you are feeding more money into the same market. It's only a matter of time, when the house you originally could afford without the deduction, becomes as expensive as the one with the deduction. Again, the law of supply and demand. What makes housing more affordable? The answer has become obvious in the last month! When all the speculators, brokers, government programs, lobbyists and market meddlers exit, affordable housing raises it's pretty head! Of course, we need basic cooperation from banks to loan money to people who actually deserve it, who are good risks, rather than loaning for speculative or greedy reasons. Since the Fed subsidizes insurance to banks thru the FDIC, we have every right within the parameters of the socalled "free market" to demand this of them.
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