Nationalization of the American banking Industry; What does it mean for taxpayers and investors?
The mere word “nationalization” strikes fear in the hearts of many free market capitalists, but should it? What does nationalization mean for the American public, what about private investors with a current stake in these companies? What will happen if these banks are not nationalized? What will happen if they are nationalized? Has any other country faced a similar situation, and if so how did they handle it? What was their outcome? By now, you’ve heard it all; Without the bailout the economy will collapse; This bailout is a farce, and taxpayers are footing the bill for Wall-Street bonuses. Who is right or wrong? Why did wall-street react so badly to the latest stimulus package approval? This analysis will attempt to answer all of these questions and more in hopes to educate the American public as to what the American Congress, Treasury, and President are attempting to do to remedy this current financial crisis, and if what they are doing seems to be the right course of action or not, depending on which side of the fence you sit, main-street or wall-street.
First, a quick (non-comprehensive) recap of what got us into this situation is necessary:
- In 1999, The Clinton Administration urges Congress to allow Fannie Mae to ease lending restrictions “that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.” Although their intentions were probably good, lack lending standards allowed lenders to put individuals into positions they didn’t care if they could repay, because the money was too good.
- In 2000, due to a re-assessment of the housing market by HUD, anti-predatory lending rules were put into place that disallowed risky, high-cost loans from being credited toward affordable housing goals. In 2004, these rules were dropped and high-risk loans were again counted toward affordable housing goals.
- The early to mid 2000’s saw a boom in housing prices, as more and more consumers entered the market, driving up existing home values and real estate prices in order to meet demand, due to a limited supply. Not to mention, extremely short-sighted risks were taken in compensation for bonuses and fees by banks, loan authorities, and real estate investors. Moreover, existing homeowners took out 2nd mortgages in record numbers, and spent the money in every way imaginable, so when their home values dropped, many owed more than their property was worth.
- By 2007, defaults on these sub-prime mortgages began to mount, and demand began to drop. Real Estate prices began their fast decline as defaults grew and demand dropped. Banks started realizing losses and investors began selling off their stakes in the mortgage back securities and the downward cycle began.
- Consumers whom once had all of this extra money because of their second mortgages and booming economy, faced the tough reality that they were now spending money they really didn’t have. In short, retail sales began their rapid decline and so did most business in America and around the world. Just as home prices were artificially inflated by an artificial demand, so were stock prices, as consumers could not maintain their spending levels forever.
And so we’ve made it to current day, and we have watched a multitude of banks and other financial institutions collapse, while others have been saved, if nothing else temporarily. The government passed a $700 billion dollar bill meant to help the ailing institutions and stimulate the economy and consumer spending. However, the first one didn’t work as effectively as hoped and so another stimulus bill has been passed in hopes of curbing this recession. However, the second one has little mention of helping these banks further, and the market reacted negatively.
Now, back to the topic at point; What is Nationalization? For this discussion, nationalization means the government steps in and assumes ownership of the institution.
So, what does that mean for the American public? Keep in mind, there’s no clear answer to these problems, or they would have already been solved, therefore, all we can do is weigh our remaining options. Let’s consider a few options being proposed or that are in place to help correct our banking problems; Option A: Provide the largest banks with recapitalization, allowing the less market dependent banks to collapse, in hopes of attracting new private investors while allowing the market correct itself (which is what we’ve already tried and it hasn’t worked to attract many private investors); Option B: Allow them all to fail, hope new businesses will be able to step in and takeover; or Option C: have the government step in and take over control and hope they will be able to save them.
- Option A hasn’t worked because it hasn’t restored investor confidence, and the credit markets have been partially frozen as a result of banks not willing to lend to each other in fears of defaults. Inevitably, these banks are destined to fail unless something miraculous happens. Not to mention, this option will drive up inflation.
- Option B is extremely dangerous as we would be further risking a complete economic collapse. It would be quite difficult for smaller banks to even get financing to start operations. This option will likely make the blow more severe and fast, however, some may argue it is inevitable. The question then becomes, what is better, take one huge hit at once, or a bunch over a time period.
- Option C is the last resort, by this time Option B has likely failed, and The US government steps in as the biggest business and guarantor of all. The problem becomes when do they step in, what adverse affects are caused such as inflation from printing money, among other issues like of lack of competition, etc. With this option, you effectively create a larger government, and in its nature is a bureaucracy and extremely inefficient.
It seems as if only a hybrid of these options makes more sense than one option alone. Option A seems to be useless, like trying to put out a high rise apartment fire with a single fire extinguisher. Instead of allowing private investors to pay for their risks, they tax all of the people and give them a minority interest, while allowing the same ineffective management to continue in their roles. It just seems as if throwing money at the problem won’t solve the issue. Private investors surely can’t mind this if they decide to stick with the company, rather than completely losing their investment. American People end up on the short side of the stick here, and investors make out better than they would have probably otherwise.
Option B seems most logical for the American public, allowing new companies to rebuild trust and redefine efficient and smart business practices. Investors probably fear this option, which may force them out of the investment market they are already wary of. Option C, given the Government doesn’t overpay shareholders for their equity positions – makes the most sense for the American Taxpayers, only if B doesn’t work first. If the government steps in, private investors get compensation, and the American taxpayer becomes responsible for footing the bills to maintain the banks. Having said that, keep in mind what these same people have done with Medicaid, Social Security, and the likes, and you will see that your chances of mismanagement may even in fact rise. The main objective in nationalizing the banks, at least in the short term, would be to restore investor confidence, etc. However, without effective legislation guaranteeing these banks won’t be allowed to do the same thing, the government would have a difficult time when privatizing the businesses once again to be able to sell the banks back to private investors,
Japan faced a similar situation to that of the US just over 10 years ago, here is an interesting analysis and comparison of their situation and attempted remedies as it relates to ours. They’re still fighting this battle today, and they used a combination of all three of the above approaches.
With regards to the most recent (2nd) Stimulus plan and why the market reacted so negatively, it should be quite obvious (I wrote a couple of articles about this). The new stimulus bill, unlike the last, does very little if nothing to aid the banks. In fact, most all of the spending is on social entitlements. It does however provide more tax relief so hopefully people will spend that money to help business. For those claiming this bill is a farce, I would agree it does nothing to address the banking problems, however, it does help a select group of people and tax-payers in general. To say we wouldn’t be any worse off without the latest stimulus, seems reasonable, to say the least.
Bottom line, Wall Street is looking for free hand-outs after having their hands slapped for scamming people by setting the market up for failure (as a result of what some would argue was congressional policy changes to accommodate low income families). No matter what though, most all people have some sort of tie to wall street, through their 401k plans or pension plans, through insurance products and more, to hurt them is to hurt yourself in many ways. On the other hand, the American people and investors alike question why you should give money once again to the same people that screwed us in the first place. There is no clear answer to our problems, however, there are clearly better options than others. Nationalizing our banks may be our last (and only remaining) option, however, if the government doesn’t immediately thereafter restore investor confidence, by reassuring investors past fraud will be prosecuted and the same problems won’t reoccur, this economy won’t come out this recession anytime soon. In fact, this may result in a complete economic collapse of the American Government and our currency, let’s not forgot what happened to the USSR not even 20 years ago, most academics laughed at the notion of their potential collapse.
How did we get into this mess; Answers to the how and why of this global financial recession.
Most of my readers come here for simple to understand answers to their questions. Thus, the following is not a comprehensive answer, however, it should be simple enough to understand for the average adult, without a college degree.
The most simple explanation to why we are in this current financial crisis is because of this so called “sub-prime mortgage” mess, and everything that followed it. Now, what does that mean? Our Federal reserve is responsible for setting monetary policy, in other words they indirectly set the rates banks use for lending. The banks then sets the standards for individuals to borrow. When the Federal reserve dropped the prime rate of lending to banks from nearly 7% to 1% in the early 2000’s, this set off a lending frenzy by the banks. The banks new that their was very little cost to their lending, so they could make money off of anyone, even those with poor credit, or so they thought (as long as demand kept increasing). Wall Street bought in on the action too, packaging up these sub-prime loans and selling them to investors, whom in turn were making a killing off of them in the beginning. As more and more people were able to qualify for loans (when they shouldn’t have been able to), they drove the prices of all homes, because as the supply of homes grows smaller, all other home prices would go up as people competed to buy them.
Then, when these people with poor credit and sub-prime mortgages started to default on their mortages, the investments started losing money, and people started selling them off in record numbers. Moreover, the banks profitability began to plummet as well. When wall-street saw this happen, everyone started pulling their money out of the market, to protect from losses.
Now, at the same time all of this “sub-prime lending” was going on, you have a bunch of good credit homeowners, who saw their home prices sky-rocket, and they began taking out home-equity loans, and spending that money on anything and everything, thinking their home value would continue to rise. Basically, they were taking artificial gains and spending it, and in turn artificially inflating companies values. When investors realized too, that these companies that were making a ton of money, were only doing so because of this “artificial boom” and that the future wouldn’t be so bright, as future profit estimates dropped, doom and gloom overtook the market.
To compound the problem, normally rational people, whom didn’t participate in any of this, decided they too should protect themselves, and so they started pulling their money out of the stock market and hoarded it, or bought up government bonds, and they still are.
Now, the banks, in trying to correct their bad investments, have tightened credit standards on consumers to the point that people aren’t able to continue to maintain their lifestyles. The banks have not only tightened consumer lending, but also business lending. With consumers unable to spend, and businesses unable to borrow, the opposite phenomena is occurring. Businesses are laying off people, as they don’t need to produce as much to meet demand, and they are stopping expansion plans and new product development as well.
When will this all work itself out? Well, the market is irrational right now, just as it was when we were on this mega spending/lending frenzy. The market will correct itself in time, and those people hoarding their cash will eventually buy back in, helping unfreeze credit markets and get people buying products and services again, and allow businesses to pick back up spending and hiring. The last major recession in the early 2000’s lasted nearly 3 years, and witnessed a near 50% decline in value. My opinion, is now is the best time to buy as the market is still unreasonably low due to consumer confidence, and these companies are worth more than they are selling for.
DJIA lowest level in nearly 12 years
How low can we go? We’re back were we started nearly 12 years ago. Since October 2007 when the Dow peaked around 14093, the stock market has loss nearly half of it’s value (49.2%) or around 6944 points. To put this into persepective, we lost around the same amount from March 2000-October 2002, 30.5 months, -49.1% (Source: Standard & Poor’s Corporation). We recovered from that recession, and every other one we’ve faced, there’s no question in mind we will overcome this one.
This “New Stimulus Bill” is a scam like the Bailout Bill and here is why
Let me preface this article with a quick background on my political beliefs, to quickly squash any doubts about this authors’ potential ulterior political motives. I am a fiscal conservative and social liberal. I voted Republican for GWB’s first election, for Kerry thereafter, and Obama most recently. I despise what GWB did to this country with regards to foreign relations but thought for the most part his fiscal policy made sense (besides the wasteful spending on Iraq, etc.). I voted for Obama for one reason only, to end this senseless war in Iraq. Having said that, hopefully you can tell that I am not here to bash Democrats or even Republicans for that matter, rather to challenge common sense and have my readers do the same.
Now, to get to the heart of this matter, the new stimulus package is a farce, and Obama is trying to use his new found celebrity status and power to push through his social agenda, on the backs of hard working Americans, and we are experiencing a bait and switch of epic proportions. Remember, I voted for the man – but that doesn’t mean I, nor should you have to agree with anything or everything he is doing, rather we should challenge it and use critical thinking in analyzing what and why he is doing what he is.
It is our responsibility to ensure our children have a future not burdened by our debt. Moreover, job creation should not come at the expense of taxing other people, by this I mean – you are not creating a new job that adds any value to the economy if you are simply taking money from someone else in that economy to pay for it. For example, if you have 30 workers, and you lower all of their incomes to pay for a 31st worker, you haven’t created any additional value. The total money all 31 workers make remains the same as the 30.
I would like to provide an analogy that will prove useful in understanding what exactly is going on in congress, and why I have such discontent with this bill in particular. Let’s talk about a company now we’ll call Company XYZ. Let’s say XYZ is publicly traded, or owned by a number of people. The management and Board is bound by their shareholders, the same way our government is supposed to be bound by its citizens. Now, let’s say XYZ is experiencing problems with their business, like the American economy, and people are being continually laid off as revenue and profits fall due to cyclical economic conditions. XYZ’s CEO, declares to all that he has a plan to to stop the layoffs, and create new jobs within the company. The workers are excited and rally behind their CEO. The CEO then creates a master plan of spending to accomplish his intentions, that has to be approved by the board and shareholders. His plan includes spending $825 billion dollars by taking on additional debt (which costs money to borrow, and is the companies and in turn shareholders responsibility to pay back). He plans to spend the following to create new jobs and help the company grow:
$275 Billion on lowering taxes for existing workers, to allow them to keep more of their money, as to have more money to spend on buying company products.
$119 Billion on fixing budget gaps for different divisions of the company, as they have been forced to layoff people because they don’t have the cash to pay them.
$117 Billion on education and training for employees.
$106 Billion for severance pay.
$90 Billion to fix the buildings, parking garages, office, etc.
$54 Billion to become more energy efficient.
$10 Billion on R&D, to hopefully make a product breakthrough.
$6 Billion to update phone lines.
$48 Billion on misc./other spending.
Now, from a shareholders perspective, which one of the above requests will actually help create new jobs with the spending? Remember, the main objective of this CEO is to create jobs, and help the company, similar to what Obama professes as his objective.
Let me answer this for you, none of them accomplish this task. The shareholders of the company would laugh this CEO right out of the company and the board of directors would think he is crazy. The CEO would in fact create new jobs like he promised, however, they would be at the expense of every single existing employee and or shareholder, and they would do very little if anything to help the company grow. Moreover, the cost of the debt would significantly counter if not overburden the anticipated benefits.
The above list is Obama’s stimulus plan and should be laughed out of congress, instead you have a bunch of idiot congressmen bobbing their heads in compliance, along with ignorant American people who have no idea they’re being scammed. They think this stimulus bill will be like the first, where they are going to get hard cash in their hands now, which isn’t the case. This is merely a trick to pass Obama’s socialistic agenda, and it should be fought tooth and nail. I’m not saying these things don’t need to happen, I’m saying he is telling us they will do something they won’t in order to get them passed. If he wants to address these issues, he should do so in a different manner and not under the guise of a stimulus plan.
We have built unmaintainable expectations in America, instead of trying to get back to the unmaintainable, allow the economy to contract as it should.. don’t waste money on frivolous ideas that will put us deeper in debt as a nation, potentially pushing our country closer to an eminent collapse.
Please Democrats, Republicans, Independents and every other party in America, quit fighting over partisan politics and following our leaders blindy, let’s team together to stop this nonsense. Please pass this article on to friends and family and spread the word.
America’s new stimulus plan is not like the last, don’t be decieved
Below is an excerpt of information taken from this article (The bold information is from the article, the remainder is my additions and discussions.
“The total size is set at $825 billion.
Tax Cuts – $275 Billion: Cutting payroll taxes by $500 per individual and $1,000 per family.
The package also includes tax loss carry backs of 5 years instead of the usual two for corporations.
This is not the same thing as the previous stimulus bill, where individuals received rebate checks. Rather, it seems this will benefit citizens for 2009 taxes, not 2008 at all. Moreover, this is less money than the previous round where individuals received $600 each, and $300 for each Child.
Aid to States – $119 Billion: The biggest part of this is to help states pay for Medicaid at $87 billion. There is also $25 billion targeted to help maintain public safety and other critical services, and $7 billion directly targeted to help keep law enforcement going.
States are generally prohibited by their constitutions from running deficits (although they have been able to find ways around that in the past) and have seen two of their biggest revenue sources dry up, sales taxes and property taxes. Without aid they would have to dramatically cut back on services, laying off many state workers and adding to the unemployment roles.
In some states like California, the projected deficits are so deep that the hole could not be filled even by cutting more than 75% of employees. I’m not sure how safe the remaining prison guards would feel if three out of four of their co-workers were laid off.
The $119 figure is not enough to fill the hole, and states will still have to make cuts, but at least they can be a bit more selective about it.
This maybe necessary – however, it is not sustainable nor does it address the root problem, the fact the medicaid has been a disaster and poorly managed. Throwing more money at the problem will not fix it, just delay it. Bottom line, this government has proven they cannot manage socialized programs.
Education – $117 Billion:
This includes $41 billion to local school districts, targeted at low income areas or that have heavy loads of special education students. An additional $39 billion will go to other school districts as well as public universities.
School districts are generally dependent on property tax revenues and have been very hard hit by the downturn in the housing market. This will prevent masses of school teachers from being laid off.
Some of this money will also go into construction projects. There is also $15 billion to states for meeting some key performance measures, although I have not seen what those measures are, and also $22 billion aimed at higher education, including increasing Pell Grants.
While many will argue that local public schools are not always the most efficient places, allowing our schools to be hard hit by the economic downturn is not a recipe for long-term economic health. Also, it’s not like that 13-year-old can just come back and take the seventh grade over again when the economy improves.
Once again, this does nothing to combat the real issue, rather it throws money at a problem that has been brewing in many inner cities for years. Why the federal government should even be involved in state education is beyond me.
Aid to Those Hit Hardest – $106 Billion:
This includes $43 billion for extended unemployment benefits, $39 billion to help those laid off keep their COBRA health benefits, $20 billion to increase food stamps and $4 billion to increase some social security benefits.
These sorts of expenditures are among the ones with the most ‘bang for the buck’ in terms of stimulating the economy. People who are really on the ropes financially are likely to spend the money quickly, which will increase the number of jobs in the economy.
Most econometric studies have found that these sorts of expenditures result in more than $1.50 of economic activity for every $1.00 spent. This is in addition to the obvious humanitarian benefits.
This does little however to fix the problem, rather it allows those affected by layoffs to live, because once again, state governments mismanaged their unemployment funds.
Infrastructure – $90 Billion:
Including $30 billion for Roads and Bridges, $31 billion to upgrade federal buildings (especially to make them more energy efficient), $19 billion for water and environmental projects and $10 billion for public transit.
This sort of spending does double-duty. It stimulates the economy now and it leaves lasting economic assets. The problem is it often takes too long to get the projects up and running to help immediately.
However, this economic downturn is likely to last a long time. I think those hoping for a second-half recovery this year are fooling themselves.
Our infrastructure is badly decayed, and this sort of expenditure would be justified even if the economy were just fine and dandy. In some cases, the return on this sort of investment comes from what doesn’t happen. Think about what the ROI of a few hundred million spent in 2002 or 2003 upgrading the levies in New Orleans would have been, even if it never showed up in any economic report.
I am disappointed that there is not more spending in this area.
While this guy is disappointed, I’m confused. We are robbing Peter to pay Paul. You are simply taxing every American to finance jobs for a select few. This may need to be done, but this does nothing to stimulate the economy on a permanent basis.
Energy – $54 Billion:
This includes $32 billion to rebuild and modernize the electrical grid, which is vital if we are going to move in the direction of alternative energy like wind and solar.
There is lots of potential for building wind farms in North Dakota, but not that much need for all that electricity in North Dakota — it needs to get to the Twin Cities and Chicago. Lots of potential for solar in Arizona, but the electricity needs to get to L.A.
In addition, a smart grid would make blackouts less common, and would lessen the need to build new baseline power plants and allow the existing plants to run closer to full capacity all the time.
The rest of the energy investments ($22 Billion) would go to weatherize and insulate public housing. Conservation is generally among the cheapest sources of ‘new’ energy production.
Science – $16 Billion:
$10 billion to fund more scientific research and upgrade research facilities. The return on such investments long term is by its nature uncertain, but often huge. In the meantime, it does stimulate the economy just like any other building project would.
There is also $6 billion set aside to provide broadband internet services to rural areas, sort of like a 21st-century version of FDR’s rural electrification efforts.
Other – $48 Billion:
Government stimulus spending is really the only way to try and stabilize the economy. The spending is over two years, so $412.5 billion per year. That works out to be about 2.5% of GDP.
The point in writing this article is that I believe man yAmericans have been tricked into thinking they will actually benefit, by a cash payment from this bill, when in fact, the majority won’t see a dime for a long while, if ever.
What is going on with our economy, the stock market, when will the economy recover?
Just about anybody could answer this question now, but do you understand the why and if this is different than previous recessions or depressions? The following research will lay out answers, in simple terms, to several different questions you may have such as; What has happened to the economy and why are so many people losing jobs; Why have home prices and the housing market dropped so low; Why were gas prices so high before and so low now; What is going on with the stock market; What is going to happen to the economy and when will the economy recover?
Keep in mind the following explanations are not full explanations, as there are so many factors involved in what is happening now that it would be nearly impossible to list them all here, rather I will focus on some of the major issues.
In order to answer what has happened to the economy and before we get more specific, we need to get a basic understanding of the nature of economies in general. This paragraph will help lay the grounds for a discussion that will focus on what is happening in the US and how it affects the world economy.
The US is a country, like many other industrial powers, with money being ultimately governed through a central bank. The central banks, like the Federal Reserve in the US, govern monetary policy, meaning they are responsible for maintaining the money supply among various other duties like setting interest rates. Think of the central bank as the parent of all the banks in the country, whether they are private or public, the banks follow the lead of their parent in setting rates. The parent sets the guidelines, but that does not mean their children always follow them, as in many cases they are free to act on their own within the rules of the law. The Federal Reserve in the US, a private institution, acts as a financial representative of the lawmakers.
Having provided this background, hopefully you can see already where the problems may arise in this system. That’s not to say you won’t have these same problems or worse using some other sort of monetary policy, however, this conversation is focused on our US and global Economy and what has happened to it as a result of central banks, and poor lending practices. Two possible things of many that could cause issues with a central bank would be the fact that they can create pricing bubbles based upon their lending rates to banks, and the banks could in turn create lending schemes that may lead to their own demise. Naturally, this system creates booms and busts, because of the nature of supply and demand.
Think of a bubble as an artificial increase in prices due to increased demand. Everyone and their brother wanted to buy a house in the late 90’s and up until the mid 2000’s, because lending practices were so lackadaisical. When everyone was competing to buy the same houses, something had to give, and that was price. Prices were driven up to unreasonable levels, considering most of the people buying the houses wouldn’t be able to maintain payments, thus they wouldn’t be able to keep the value of the houses so high. The good guys that were qualified to make payments severely overpaid too, because truly non-qualified buyers were able to spend money on credit they didn’t have to payback or couldn’t afford when their adjustable rate mortgages ballooned. Basically, there was a bunch of people banking on the price continuing to rise, when at some point the collapse was inevitable.
For example, recently lending practices have came back in line with being more reasonable, as it was determined previous lending practices were leading to too many defaults and banks were paying the price when their customers couldn’t pay their bills.
So, maybe you can start to see where I’m going with this; We we’re living at unmaintainable levels in the past with regards to housing, jobs, etc. Now, when this housing bubble popped, and prices had to come back down to more reasonable levels, reasonable people could afford, it sent a ripple affect throughout the entire economy. Suddenly, large banks were deemed grossly overvalued, and their stocks plummeted. The stock market was over 14,000 at its all time high in October of 2007. Soon after all hell would break loose as fear gripped investors and they began to perpetuate the problem by pulling their money out of companies and investing in the government. Most of these people had legitimate fears, however, they only compounded the problem by pulling their money out. As you’ve seen, companies that no longer have capital to invest in their companies, will stop creating additional work, and will be forced to downsize to accommodate their new forced direction. This truly has a downward spiral affect similar to an exaggerated boom, the difference being the economy shrinks back disproportionately.
Instead of smoother cycles in the economy, we see massive spikes in both directions until the economy stabilizes and people start putting their money back in to the markets – allowing capital spending to continue in companies and jobs to be created once again.
The cost of gasoline/oil in the US saw a similar bubble, where expectations on demand were unreasonable, and speculators bid the price up to unmaintainable levels. When reality set in, in under 6 months the price had dropped by 2/3.
Currently, the market is so shaky in part simply because people are not spending because of fear, not investing because of fear, and they are creating their own mess. Eventually, people will come back to their senses when sentiment turns around, and the market will once again explode and shoot up to levels it won’t be able to maintain, to drop once again. In order to be a good investor, you need to recognize the signs that the market is turning one way or another.
If history is any indicator this economy will recover by the end of 2009 or shortly thereafter. Do your part and spread knowledge to combat these irrational fears and help your portfolio get back on track. Check out more of my articles to help you understand this sometimes complicated world of accounting and finance.
