What to make of the financial fallout

Up, up up your premium
up up up your premium
up up up your premium
up up up your premium

Scribble away and balance the books
Scribble away and balance the books

It’s fun to charter an accountant
And sail the wide accountancy
To fin, explore, the funds offshore
And skirt the shoals of bankruptcy

It can be manly in insurance
We’ll up your premium semi-annually
It’s all tax-deductible
We’re fairly incorruptible
Sailing on the wide accountancy

Sail away!

- “Accountancy Shanty” by Monty Python

If you have ever seen the Monty Python movies, then you would recognize the lyrics above. The battle between the old business and the new corporation leads to many hijinks including filing cabinet cannons and sword fights with umbrellas and briefcases. The silliness of it all can only be matched by the collapse of many of our large financial companies and institutions over the past few weeks. Well, it would be silly if it wasn’t so serious.

What was set off by the subprime mortgage meltdown in 2007, compliments of an overactive housing market fueled by adjustable rate mortgages (ARMs), has led to many large financial holding institutions to sell themselves off to outside investors, break their company up into parts, declare bankruptcy, or worse of all, being taken over by the government. Though it isn’t the first time the government has taken over businesses to help stabilize a business sector, it is the first time that the involvement has reached the scale that we are experiencing today. Forecasts show that, by the time all is said and done, the government will spend well over $1 Trillion; or basically socializing the large capital financial sector.

In many ways, the government has been involved for years. Freddie Mac and Fannie Mae, for example, are “quasi-government entities” since they were government-sponsored entities (GSE). These GSEs are created by the government in order to ensure that there is credit available in the financial and farming industries, that in return lowers the cost of borrowing so companies can do business. In other ways, primarily through regulation, the government controls how loans and transactions can be made between businesses to prevent abuse and fraud.

However, there was no active involvement over the lending process to review what types of loans were being provided to high-risk borrowers that were being unfairly targeted by lenders. With the government keeping interest rates artificially low to sustain the economy while promoting home ownership and “the American Dream,” the housing market boomed during the midyears of this decade to a point where the market became oversaturated. Since publicly traded companies require forward-looking growth in order to sustain their market value, some financial institutions were willing to create loans that had higher risk in order to sustain activity. These loans were bundled and resold on the market by other institutions willing to assume the risks for higher returns. As the dominoes of foreclosures began to fall, so did the housing prices, resulting in an oversupply of houses on the market without buyers.

Companies were left with exposure to the fallout from the subprime crisis, resulting in margin calls by the market, loss of access to new capital, and falling revenue streams. This negative pressure has brought us to where we are today. Congress and the White House are currently working on a new $700 Billion bailout package to help failing financial firms that have a significant impact on the larger financial market. This package includes buying up “toxic assets” that should have never been created to begin with through the Troubled Asset Relief Program. Some key points in the proposal include:

• $50 Billion provided to insure money market and mutual fund programs
• Fannie Mae and Freddie Mac will continue to buy mortgage-backed securities
• Purchasing troubled liquid assets off of firms that cannot support them

The package is being met with resistance, as some feel additional items should be added, including capping the retirement packages of CEOs of the failing financial systems, increasing oversight of the bailout program, and how the government and taxpayers should benefit from the improvement of the financial condition of the companies that benefit from the governments action. Others fear that the bailout package is being rushed unnecessarily, leaving the possibility of more problems being created rather than helping the situation. This has also spread over into the current Presidential race. While both Obama and McCain spar against each other about the details of their plans “if they were President,” the both agree that there should be increased oversight in the bailout program and some level of consumer protection be implemented to prevent future abuse by the financial sector.

While much of this might sound Greek to you (and I admit it, some of it is even over my head), you can feel assured about one thing. You are seeing the birth of a new economic model. The old guards of the market are fading off into the sunset while new “hybrid” systems take over. Investment banks will merge or transform into traditional banks, expanding their access to capital to spread out their risk potential. Foreign investors will gain a greater access to our economic machine, holding controlling assets long enough to make a profit and to sell the stakes back to us. You will probably see non-banking institutions entering the market as well, such as retail and technology companies with large financial assets willing to take on some risk for a large possible payoff in the future. Also, as the economy recovers, the government will be able to spin off the assets they’ve purchased, hopefully at a profit.

So while things look bad now, they will improve in time. We have many examples in the past from where we can draw hope. Is this the time to invest in stocks as a private investor? If you are in a financially secure position, then now could be a good time to pick up stocks that have been pulled through the ringers as the DOW swings 1000 points in just a few days. For others, I would wait until things calm down, just so you don’t put your financial security at risk. Until then, everyone should make sure that their savings are held in FDIC insured banks, and that you do your own research to make sure your banking institution is weathering the storm. While we are in a financial “meltdown,” most banks are actually doing quite well. So do your homework and practice a little patience.

Related articles:
A Disgruntled Republican – “What Caused the Economic Crisis”
Globe Street – “Feds Unveil Troubled Asset Relief Program”
Miami Herald – “Democrats in Congress add restrictions to $700 billion bailout bill”
Bloomberg – “McCain, Obama Call for More Oversight, Limits on Executive Pay”
Reuters – “Obama, McCain battle over financial crisis”
Seattle Post-Intelligencer – “McCain should have stood by his words”
Associated Press – “Congress, Bush team agree on some bailout terms”