Paulson's Bailout Plan Is Financial Shock And Awe

It's another Monday and there is another government bailout to talk about in the sub prime mortgage mess.

However, this time its the "mother of all bailouts". U.S. Treasury Secretary Henry Paulson has proposed and the Congress will soon approve a taxpayer bailout plan for everyone.

The Paulson bailout plan will use at least 700 billion taxpayer dollars to bail out toxic mortgages from every United States financial institution and even large U.S. banks that are foreign based.

In addition, the Paulson bailout plan saves any money market mutual fund that was in danger of breaking its one dollar net asset value. There were two such money market funds that were in that dubious category last week.

While there can be no doubt at this point that the Paulson bailout plan was necessary to save the financial markets from the abyss, the plan is financial shock and awe to the American taxpayer nevertheless.

The commitment of 700 billion in new taxpayer dollars to save the financial markets along with the cost of the Iraq war and the already huge federal budget deficit projected for next year will dramatically limit the next President's ability to spend any money.

So, any Presidential candidate that still maintains that he is going to cut taxes, provide National Health Insurance or any of the other myriad of vote pandering treats in the election 2008 goody bag is simply not facing fiscal reality. Make no mistake about this, American taxes are going up and the growth of the economy is going to be subdued during the next Presidents first term in office.

It is really remarkable how poorly our elected politicians and 2008 Presidential candidates have handled this financial crisis during the last week. Last Tuesday, Republican John McCain said: "We cannot have the taxpayers bail out AIG or anybody else." By Wednesday, he had completely changed his mind.

How about this strange quote from the Arizona Republican: "the fundamentals of our economy are strong". Unfortunately he said this as one brokerage house had just filed for bankruptcy, another was about to, and the Dow Jones industrial average had tumbled 504 points in a single trading day.

Meanwhile, America is still awaiting the economic plan of Democratic candidate Barack Obama. He has already delayed unveiling his plan twice. I guess at this point, he has just decided to vote "present" on the current financial crisis. It's apparently a pattern of behavior since he voted "present" on 130 different occasions when he was a member of the Illinois State Senate.

The leadership in the Congress was not much better. In the United States Senate, Majority Leader Harry Reid is quoted as saying "no one knows what to do" while in the House Of Representatives, Speaker Nancy Pelosi initially promised to hold hearings on the crisis after the Congressional vacation.

This week both Republicans and Democrats will spend more than 700 billion dollars of taxpayer money and then go home on vacation. In the 2008 election, it will be business as usual as the candidates continue to make campaign promises that they cannot hope to deliver. However, despite the Congressional commitment of a huge amount of taxpayer money and all those campaign promises, this financial crisis is far from over.

A long and deep U.S. recession has now increased in probability. Indeed, defaults on credit card payments could eventually require the Treasury to commit more taxpayer bailout dollars for banks and credit card companies. In addition, a run on hedge funds is very likely and this whole mortgage mess may well spread throughout Europe.

Paulson's bailout plan of 700 billion taxpayer dollars is certainly American financial shock and awe. However, the sobering reality of the plan is that as an economic solution, it may be only phase one.

FannieMae, Freddie Mac And The Magical Piggy Bank

The sub prime mortgage crisis continues to get worse. It seems like every week that the federal government takes over another bank in the financial industry.

In addition, it was only six months ago, on a weekend, that Bear Sterns made international headlines as it became a J.P. Morgan entity backed by Government guarantees.

This last weekend it was government sponsored home mortgage lending giants FannieMae and Freddie Mac that became the recipient of federal government oversight. The government bailed out both financial institutions and the tab to that magical piggy bank known as the United States taxpayer may be as much as 200 billion dollars.

Meanwhile, the CEO's of these two failed home mortgage giants will not have to worry about their next meal any time soon. Fannie Mae CEO Daniel Mudd received $12.2 million in total compensation in 2007. Mudd's pay included his $990,000 salary, a $2.23 million bonus and a $9 million "long-term incentive" award. In 2006, Mudd received a $3.5 million bonus and a long-term incentive award of about $10 million. His total pay for 2006 was $14.45 million dollars.

Over at Freddie Mac, Chairman and Chief Executive, Richard Syron pocketed nearly $19.8 million in compensation in 2007, even though the mortgage company's stock lost half its value last year.

However, these salaries were apparently not enough reward for corporate failure. Daniel Mudd, the departing head of Fannie Mae, is expected to walk away with $9.3 million in pay and retirement benefits for 2008 under the terms of his contract.

Richard Syron, the departing chief executive of Freddie Mac, could walk away with $14.1 million. Mr Syron's larger payoff follows a clause added to his employment contract last summer when the first signs of the credit crunch began to emerge.

It certainly makes you wonder what the term pay for performance means in the business world today.

So, what happened? Why has the government gone from sponsoring these mortgage giants to owning them through a bailout that may cost the taxpayer as much as 200 billion dollars?

A financial audit by Morgan Stanley concluded that the accounting of the mortgage companies, (which represent nearly half of the entire mortgage market) while legal, enabled Freddie, and to a lesser extent Fannie, to overstate the value of their reserves.

Indeed, free-market advocates had warned of this impending disaster for years as Fannie and Freddie used an implicit government backing to borrow at will, with only a small mount of capital to protect them from nasty surprises like the recent sharp decline in housing prices and rise in foreclosures.

Look for the stock market to rally in relief since taxpayer dollars are being used to clean up our national mortgage mess. However, banks will continue to be seized and backed by taxpayer dollars. The 2008 Presidential election campaign will proceed with a never ending list of candidate promises backed by future taxpayer dollars.

Meanwhile, the current United States budget deficit is already projected to be over 480 billion dollars next year, and it still does not even fully reflect the total cost from the war in Iraq or smaller tax reciepts from an extended recession.

So, as corporate CEO's clean up financially and have no accountibility for their own failure, what will prevent executives from other financial companies to gamble even more recklessly in the future? After all, they will still get rewarded even if their gamble fails since the taxpayer now apparently assumes the risk of each financial company failure.

Indeed, it really is a house of cards that all depends on that magical piggy bank courtesy of the United States taxpayer. At some point it is destined to get very ugly when that magic finally wears off.