Paulson's Plan: Too Little, Too Late

Last week, Treasury Secretary Paulson and Fed Chairman Ben Bernanke faced Congressional leaders with a reported forecast that we are "literally days away from a complete meltdown of our financial system." Apparently, the politicians were stunned into a long silence.

 If citizens across the country could glimpse the horror seen by the Congressmen (of which we have long warned), then widespread panic would truly be the order of the day. In particular, people will be shocked to see how Paulson's seemingly vast request to Congress for some $1 trillion is utterly dwarfed by the likely problem. Of course, Paulson does not want to scare Congress. So he has offered them his own version of a teaser mortgage rate of just $1 trillion. The true figure will only kick in later, like one of the adjustable rate mortgages that tempted millions of optimistic home buyers.  Once Congress is locked in to a "blank check", the funds will keep rolling until the presses run dry.

To put the problem into perspective, let's just consider some base statistics.The publicly issued debt of the Unites States was, until very recently, a massive $5.3 trillion. The total debt, including non-public IOU's and unfunded obligations including social security and Medicare, is now a staggering $50 trillion.  The total annual wealth generation, or GDP of America, is some $14 trillion.

Contrast those figures with the current debt problem ascribed to the reckless pursuit of predatory lending. Incidentally, predatory lending was made illegal in most states until overridden by President Bush to protect Wall Street profit opportunities. The U.S. mortgage holdings are some $14.8 trillion, including some $3 trillion of commercial mortgages. Local government debt is some $3 trillion. But, even these gigantic figures pale in comparison beside the $20.4 trillion of consumer and corporate debt. Therefore, the total of non-Federal Government debt is some $38 trillion.

Of course, not all of it will default.  All things being equal, possibly only a small proportion will fail, at least initially. But today, all things are not equal. We know that we are heading into a recession.  This means that increasing amounts of debts will default.

The main problem is that predatory lending incurs a high default rate. So if only 10 percent of outstanding loans default, the Government will have to raise some $4 trillion, or more than 5 times what Congress is being asked. It will increase the U.S. Government public debt by some 80 percent.

This will threaten the triple-A credit rating of American Government debt.  It will also 'crowd out' corporations and entrepreneurs from crucial debt funding.  Finally, it will put upward pressure on interest rates at precisely the time when lower rates are called for to avoid recession slipping into depression.

If the economy moves into a severe recession and then depression, default rates will explode. These, in turn, will cause stock markets to implode, as they did in 1929.  In addition, the U.S. dollar is likely to plummet, driving up the trade deficit in the longer term.  Considering these factors, many of which the Government prefers to hide, things look bad -- very bad.

It does not take a rocket scientist to see that we face a very serious situation and that the $1 trillion Paulson rescue plan, although well intentioned, is far too small and too late to avoid disaster. So what should investors do?

An old maxim states that gold makes sense when nothing else makes sense.  Today, not much does make sense.  Gold is likely to explode, at least in the initial stages of panic.  In a recession, cash becomes a King. In a depression, gold is an Emperor.

In the current panic, many investors are jumping on U.S. Treasury bonds as a perceived life raft. But teetering on the shaky foundation of U.S. dollars, T-bonds are a trap to be avoided.  As the U.S. dollar is likely to erode fast, the sovereign debt of countries with strong currencies, such as Swiss francs, are attractive, even with a negative yield.

In these precarious times, think return of capital, not return on capital.

Comments

[Brittanicus:]

Hundreds of thousands of mortgages were sold to illegal immigrants, who could hardly afford the high standard of living in this nation. Incorrigibles brokers fraudulently negotiated loans for homes with little or no cost in moving into a property. Today we have the largest bail out of giant mortgage firms, accelerated foreclosures as illegal alien families unable to pay the escalating mortgages walked away. By flooding the market with unqualified buyers, government bureaucracies have artificially stimulated housing demand, which caused home purchases to explode, leading to the unsustainable housing price bubble that has finally burst.

www.familysecuritymatt... Just about anyone can get a "stated income" loan provided one's FICO SCORE is high enough. By lowering the scale enough, Uncle Sam has indeed brought diversity to house ownership. However, at a terrible cost? Now we have a economic rapture, that taxpayers must bailout that has placed the country in almost economic collapse. All in the name of diversity, given to us by greedy corrupted Wall street and tainted politicians. Judicial watch for facts on corruption. Numbersusa to stop this decline in our sovereignty.

2008 Sep 24 06:12 PM

[a believer:]

Good article.

There is a kind of necessary justice in seeing The Death Of The Leveraged Debt Industry. In fact, it was too long in coming.

The government plan, if enacted (which is doubtful), will fail. I see this as a good thing. Everyone needs to go back to producing real goods and services, investing their earned (not borrowed) income in (gasp!) machinery and sources of production. Remember that?

Unfortunately, the theives, crooks and shysters that became addicted to dishonest gain will still be with us.

Be on your guard!

2008 Sep 25 12:45 AM

[henarl:]

"In a depression gold is an emperor" When cash becomes worthless, as in hyper-inflation, the government will outlaw gold, just as FDR did in the past. Also, no one will be willing to trade the absolute necessities of life - food, water, shelter, safety, etc. for your gold. Better to invest in guns and ammo and make friends with the meanest nastiest people you know.

2008 Sep 25 02:25 PM

[Moon Kil Woong:]

This is a good point to the problem. The MDS market is 61 trillion... a massive sum to the few trillion's in actual mortgages meaning that the banks (Goldman Sacs) is gambling with them and would like a bailout please... a paltry $700 billion will pay for a little over 1% of the problem. By the way, those that don't know the mortgage default swap market... it's a ponzi scheme requiring more and more fake insurance backed by nothing to support more and more AAA mortgage bonds that are backed by nothing because the backing is MDS. So those who write MDS contracts must buy more MDS contracts to protect themselves from their prior liability... who need to buy more MDS to back those... And each rotation requires more contracts because the price of the MDS insurance keeps growing.

2008 Sep 26 05:35 AM

[NOWHEREMAN:]

A couple of hand held crossbows if your wife objects to guns, will also do in a pinch. Meanwhile, a couple of years worth of MREs should be stored, maybe in the spare bedroom.

Yup, Yup, Yup.

You do not have do any of the above. 12-21-2012 the world ends, the Crystal Skulls say so.

2008 Sep 26 10:18 AM

[ourazsky:]

As long as we continue to pour $$$$ into a sinking ship eventually it will SINK!
We need to beach the ship, start to rebuild and fire the Captain's.

2008 Sep 27 08:21 AM