Bondholders Are Unjustified Big Winners in Treasury Plan - Hussman

Excerpt from the Hussman Funds' Weekly Market Comment (9/22/08), which this week takes the form of an open letter to Congress on the financial crisis:

As an economist and investment manager, I am concerned that the plan advocated by Treasury is essentially a plan to bail out the bondholders of financial institutions that made bad lending decisions, with little help to homeowners who are actually in financial distress. It is difficult to believe that the U.S. government is contemplating taking on the bad assets of these institutions at probable taxpayer loss and effectively immunizing the bondholders (and shareholders) of these companies...

These institutions are not failing because 95% of the assets have gone bad. They are failing because 5% of the assets have gone bad and they over-stretched their capital. At the heart of the problem is “gross leverage” – the ratio of total assets taken on by the company to its shareholder equity. The sequence of failures we've observed in recent months, starting with Bear Stearns, has followed almost exactly in order of their gross leverage multiples. After Bear Stearns, Fannie Mae, and Freddie Mac went into crisis, Lehman and Merrill Lynch followed. Morgan Stanley, and Hank Paulson's former employer, Goldman Sachs, remain the most leveraged companies on Wall Street, with gross leverage multiples above 20...

The stockholders and bondholders of the company itself should be the first to bear losses, not the public. That is the essence of what a free and fair market, and a responsible government would enforce. The investors in the companies that produced the losses should be accountable for them, and the customers and counterparties should be protected.

Comments

[bapna101:]

Damn right !!

2008 Sep 22 10:10 AM

[swygert@law...:]

John, your comment is far too simplistic so I will offer a slightly less simplistic reply. Homeowners need to borrow monety to purchase their homes; businesses need to borrow money to invest in their enterprises;
banks need to borrow money to lend to home buyers and businesses. Banks borrow in essence by selling equities to speculators and bonds to investors. By definition, equity holders are speculating; bond purchasers are a bit more prudent, trading off high potential returns for more security. The base lenders in our scheme of things are bond buyers, especially when they buy investment grade bonds. Wipe them out and the whole system collapses. Opps, I guess it has. OK, then the base lender in our new scheme of things is the Fed. Opps, then the base lender to the Fed is, you're right afterall -- the taxpayers. I see what's coming -- subprime tax-loans followed by federal bailout of taxpayers. What a great country!

2008 Sep 22 10:22 AM

[Jason Rines...:]

Any bailout of taxpayers will be a another token such as an additional stimulus check. The US government at this point should take out an additional $300 B for energy independance and other infrastructure projects that create skilled jobs. If the debt is to be shouldered by taxpayers and the bill differed for a couple of years then job creation is critical to begin a recovery.

2008 Sep 22 10:51 AM

[buyitcheap:]

The reason is that most of the bondholders were foreign countries and SWF's. We had little choice or they would not have showed up at the next treasury auction.

2008 Sep 22 10:57 AM

[Franc:]

Fannie Mae and Freedie Mac were two of the largest frauds in financial history. They were protected by a variety of politicians in Congress. They blew up and took down most of the banks. Add in 20 to 40x leverage, hedge funds naked shorting, no uptick rule for shorting, The Community Reinvestment Act which forced banks to lend to borrowers who had no chance of paying back their mortgages, 1% teaser ARM mortgages with nothing down, ending Glass Stegall, the list goes on and on. Blame Congress for a lot of this. Hedge funds own Washington. Hedge funds are the same thing as "investment pools" that were outlawed after the 1929 crash due to excessive manipulation. The biggest Washington culprits of this disaster are the Senators from NY, NJ, CT and Illinois in the name of Obama. They will bailout Wall Street and they are now trying to bailout mortgage holders by essentially giving them a free house. Crony capitalism in Congress, Fannie & Freddie, excessive leverage and a blank check for hedge funds caused this.

2008 Sep 22 11:25 AM

[venividivici:]

Good article but buyitcheap has put his finger on the reason they're so determined to protect the bondholders. America needs to borrow, what is it, $3 billion dollars each and every day and it all comes from overseas. If the interests ot those providing the money are not protected that vital source of finance will dry up very quickly and Hank and Ben know that. As America sinks deeper and deeper into debt so independence of action goes out the window.

2008 Sep 22 01:36 PM

[Reflections:]

You are bang on target.it is the bondholders who nee to take hit and not taxpayers.privatise the profits and socialise the losses.great free enterprise being advocated by current and ex employees of Goldman..Hank paulson included.

2008 Sep 22 01:52 PM

[taojaxx:]

Surprised the headlines don't mention stockholders (among which managers, with fat bonuses), still bigger winners! They want me to share their losses. Can't recall they shared their bonuses.

2008 Sep 22 06:11 PM

[Chris B:]

Assets = Liabilities + Owners' Equity

so...

Government = National Debt + Taxpayer Equity

Which do you think has control over the assets - the foreign creditors who own the debt or the taxpayers?

Since the government would run out of money if the lending was ever cut off, I would say the foreign creditors. Just like in a bankruptcy, the assets have been seized and used to try to make the creditors whole. The fact that our own government would shift open market investment losses from the creditors to the taxpayers illustrates this realization nicely. We no longer own the government. We squandered it away on silly wars and porky budgets.

2008 Sep 23 09:23 AM

[Sapphire:]

If they don't repay the bondholders, the whole system will collapse further, as they won't be able to raise capital go keep going. I didn't get scammed into buying a big house I couldn't afford - I live in a modest condo and don't have a mortgage. Nor did I try to make the big $$$ by playing the stock market. I sacrificed the potential for big market returns when I bought long-term AAA -rated bonds issued by a financial institution paying a modest amount of interest to keep my retirement savings safe. People like me should not foot the bill for this mess either.

2008 Sep 26 09:24 PM