Roylat.com

With very little fanfare and relatively scant media attention, the federal government has expanded its guarantees and loans to financial institutions to ten times the hugely controversial $700 bn Paulson bailout – $7 trillion! Every one of you should be aware of this in terms of your financial planning and be conveying your displeasure to your congress people and Obama.

“The money that’s been pledged is equivalent to $24,000 for every man, woman and child in the country. It’s nine times what the U.S. has spent so far on wars in Iraq and Afghanistan, according to Congressional Budget Office figures. It could pay off more than half the country’s mortgages.

“The above quote is not from some fringe radical or stock-market doomsayer. It is from an article in Bloomberg, a mainstay of the financial mainstream:

The whole article is probably too complex for most to plow through, but take my word for it, you should be concerned.

Bernanke and Paulson say, “It’s an investment. There is little risk.” But, the degree of risk is unknown, because the collateral being guaranteed contains lots of toxic stuff of unknown risk. At the least, the guarantee of existing debts by the federal government is a huge transfer from us taxpayers to the owners of the debts (mostly financial institutions).

An estimate in the Bloomberg article is that lower interest rates due to the federal  guarantee(by us taxpayers) would amount to a transfer of $74 billion per year if applied to the entire $7 trillion. This would seem a minimum estimate of the cost, because in many instances, the real cost will be higher. Understand, too, this is a subsidy to the institutions that created and/or profited from the mess from which we are all suffering.

What will this all mean ultimately? It is too early to know, but not too early to know that there are HUGE risks in the financial and economic spheres. The feds are throwing money at the problems in magnitudes too large to comprehend, but so far the problems keep expanding. They seem likely to keep expanding for some time.

Most of us are suffering directly from the decline in the stock market, the rise in real interest rates (those that businesses can borrow at, as opposed to the zero rate the government is giving the big banks), the decline in employment opportunities, and the fall in real estate values.

Obviously, too, the shareholders and lower level employees of financial institutions are suffering greatly. But, given all of the suffering that has occurred, it seems unfair and wrong-headed to use taxpayer-backed credit to benefit the shareholders and debt holders of the financial institutions. The latest Citi bailout increased the price of Citi shares by 50% in one day! Preventing the collapse of the economy may require the government to guarantee the debts of banks, but if a bank gets to point of insolvency absent government aid, its shareholders should fare no better than they would in bankruptcy (which would be what would occur with the government aid) — and in bankruptcy, the shares would be worth zero.

The government should devise a standard process for coming to the aid of banks that have no alternative to government bailout. Basic components of the process should be: 1) control of the board of directors (which includes control of compensation policies and lending policies); 2) the equivalent of bankruptcy for common shareholders and debt holders; 3) assumption by the government of the entire possibilities of future gains as well as losses; 4) continued operation of the bank without interruption. Only under this set of conditions will the taxpayers “investment” garner the same benefits that would accrue to a private investor who came in and took over the otherwise insolvent institution. Only in this way can we, the ultimate holders of the debt, be sure that the institution is operated in the broad public interest.

Meeting the listed conditions will be equivalent to nationalizing the bank. This will be an anathema so some, but we have been in effect nationalizing the downside risk while allowing the private owners to own the upside profits.