Possibly the biggest parting gift the Bush administration has left to us, the U.S. taxpayer - after looting the treasury to the tune of at least 350 billion - is to make us the guarantor of several trillions in "toxic assets."
Due to the absolute absence of transparency in the process, I'm not sure anybody actually knows what the actual figure is. The figures I have seen most often are 1.8 to three trillion dollars, truly staggering sums. For all anyone knows, however, the real figure could be five times that, ten times that or even more.
Paranoid fantasy? I sure as hell hope so. Until all the Bush Treasury and Federal Reserve last minute deals are unraveled, there is absolutely no way of knowing.
The Bushies have been done it again, however. They have set a classic "mousetrap." Because of their actions, any action we take to help troubled homeowners other than outright subsidy will be economically disastrous for the economy - possibly leading to destruction of our currency.
How can that be? I'll explain below the fold.
Nobody is now sure what actual value the various derivatives the Fed has guaranteed in our behalf actually hold, nor what value the Fed has placed on them. By design, that makes the subject very difficult to discuss. The Bush looters wanted to get out of town well ahead of the citizens with pitchforks. Unless I very badly miss my guess, it will turn out that we are on the hook for far more than Paulson and Bernanke have publicly admitted.
Let's be optimistic, however, and assume that (for the sake of clarity and round numbers) we have guaranteed five trillion of the various derivatives that various financial institutions (feel free to divide that figure - or multiply - as you wish) are now holding. If the Fed has been prudent (HA!) all those assets will eventually have value, and so we are told. We are also told that we will eventually even profit!
Great. That will be a neat trick - especially since the entire purpose of the guarantees is to make salable that which is not, paper that nobody else wants. Especially since 60 trillions of "derivatives" (bets) were written on ten trillion of U.S. mortgages. This is a dramatic oversimplification, but those were essentially bets that those ten trillion in mortgages would be paid off as written. In other words, and this is key, any action taken to allow "cramdowns" (in bankruptcy), interest reduction, principal forgiveness, or other homeowner friendly loan modifications would drastically and negatively affect the value of the paper the Federal Reserve has guaranteed in our name!
If the Fed turns out to simply be guaranteeing the underlying mortgages, that is a problem, but not a gigantic one. Houses are hard assets, most of the mortgages will be paid off and relatively few will turn out to be dead losses. Unless housing prices recover, we will lose a percentage of our money, but probably only (ONLY!) a few hundred billion - at worst.
Wanna bet?
It appears that isn't the case, however, and the vast majority of the "weapons of financial mass destruction" derivatives are not backed by any hard asset! In other words, reducing the value of the underlying mortgages upon which the derivatives (such as credit default swaps) are based, effectively makes that CDS worthless.
In attempting to avoid jargon and for the purpose of simplification, I realize that I am guilty of gross oversimplification, that the problem I have outlined is completely nebulous in the absence of hard numbers regarding how much toxic paper and what kind the Fed has guaranteed.
The crux of the matter is that any action we take to allow writedowns of existing mortgages could cost us ten times as much as the same amount of direct subsidy to the homeowners by making worthless toxic paper the Feds have guaranteed in our name!
Untangling the threads of this mess will be perilous. There seems to be a certain gay abandon lately regarding the bank bailout and the trillions it will cost. These trillions will preserve a very few jobs - but create none.
FDR invested in this country - and everyone who lives near a dam is still collecting a dividend in terms of lower electric rates. Those investments made American products cheaper and promoted cheap agriculture. We all still benefit. The bailout created zero value; it falls into the "bad money after good" category. Not only that, but running the (figurative) printing press 24/7 will have consequences. I anticipate serious inflation down the road as those chickens come home to roost - and they will. There is no such thing as "free" money - no free lunch.
Action: We must know exactly how much and what kind of assets the Fed has guaranteed - and before we make other policy. Contact your representatives. Remind them that knowing things like this is actually their job.
We should be prepared to consider direct subsidy (with all the political fallout that would entail) to troubled homeowners; it may be far cheaper than paying off the guarantees we have made.
Disclaimer: I am a renter. By propping up home prices, direct subsidy to homeowners is against my (short term) economic interests. I would love to pick up a nice house for a song; I don't want the country to collapse around me as I do that.
I own no stocks - especially including bank stocks. Matter of fact, I wrote a diary LET THE MARKETS CRASH! Start again from scratch. opposing the bank bailout and another proposing a fix: How to fix the credit crunch
I do want to keep families in their homes; that's very important. How we accomplish that is even more vital to our health as a nation.
I have proved nothing; consider this a "heads up." It is a fact, though, that the final act of this administration was to lay a minefield regarding a consumer-friendly solution to the credit crisis.
Update: Rescued! My first rescue, and thanks. More importantly, this would have been an easy diary to dismiss - but it's obvious from the comments that you "got it." It's way past time to shine a very bright light on the actions the Treasury - and even more importantly, the Federal Reserve - have taken since the crash.