This Crisis Beyond Politics

This is not a “Political” Crisis. It is very real, and it is at your back door.

When the president of the United States goes on national television to talk about a financial crisis, we should pay attention. Rather than seeing it as just another “political” move with no more sincerity than Cruella DeVil petting a Dalmatian puppy, we should see it for what it is: a desperate cry of “Look out!” before we drive over a cliff.

I know that Congress is not filled with leaders that can process information quickly and then make rational, informed decisions. No, politics tends to attract a different kind of human (some might call them subhuman) who often sees life as a series of maneuvers and negotiations. For them, nothing is black and white, good or bad, but different shades of gray that spill across the aisles in the form of legislation.

This is a time when politicians must shed their skin and, for once, do something that is not politically motivated, but people motivated, nation motivated. Millions of human lives are teetering on the brink of ruin, unless Congress takes swift and decisive action. A small or “gradual” fix will do nothing but delay disaster. Doing nothing will send the planet into an economic freeze that could cure global warming. It is this bad.

Our banking system works on money (financial ratios) and faith. A banker must have faith that the money they loan will be repaid. Otherwise, the bank goes out of business. Depositors must have faith that a bank will survive, and that their money is safe. Otherwise they withdraw their money. If depositors withdraw their money, the bank must call in loans immediately (remember those ratios). In a time of crisis, there is often no other place that businesses or individuals can replace their loans, so they default. This causes a further erosion in capital and the cycle continues.

There are organizations whose job is to audit and regulate financial institutions. The Federal Reserve is one of these, so I will use them in my example. The Fed regularly goes into banks and looks at their books. They make sure that the bank has the assets they claim to. They make sure that they remain financially strong, so that a business downturn, or a small crisis in confidence won’t put the bank out of business, or lose depositors’ money.

For years, many banks have been purchasing CDO’s (mortgage backed securities) as a way to invest, hedge and bring profits. Until recently, these CDOs were considered valuable, and were seen by regulators (hence the general public) as being safe. Now that many of these securities have proven to be worthless, banks must assign them a much smaller value.

Banks are allowed to lend money based upon their asset (and deposit) base. The more money they have in reserve, the more they can lend. They must adhere to certain “ratios.” For example, let’s assume for every dollar of deposits, I can lend out fifteen. Using this example, if I have $1 million on deposit, I can lend out $15 million. If these assets (deposits plus securities) decrease in value, a bank must reduce its loan portfolio to stay within the financial regulations (laws). If one of my depositors withdraws $500,000, this means that my bank must either replace that money, or call in $7.5 million in loans.

If I am a bank that owns $1 billion in mortgage backed securities, I might have lent out $15 billion using them as security. If these securities drop in value to $500 million, my bank must either replace it, or call in $7.5 billion in loans. This would cause big problems in the business community and many jobs would be lost.

By my math, our nation’s banks (both commercial and investment) own trillions of dollars worth of CDOs (mortgage backed securities). Until recently, the Federal Reserve has been lending money against these securities at something approaching (if not meeting) their face value. This has allowed the financial system to proceed as usual. The problem is, the Fed is not allowed to do this forever. At some point (that means now) the Fed (and other regulators) have to recognize the true value of a bank’s deposits and securities, and force them to adhere to the lending ratios that will keep them solvent.

Here is the problem: our financial institutions are holding hundreds of billions in worthless “assets” that must be accounted for. These securities must be assigned their true value, and loans must be reduced to reflect this capital base. If this happens, businesses and individuals with the highest credit ratings will have loans called in. New loans will virtually cease, and our economy will drive off that cliff, or come to a grinding halt. This is monumental.

The president is proposing a bridge that will allow the Federal Government to purchase these deflated securities at full or near-full value. This will allow banks to avoid calling in trillions of dollars in loans. It might help avoid putting millions of people out of work. I might help us avoid a global recession, or worse.

If this plan does not get passed, look for a friendly call from your banker explaining that, despite your AAA credit, despite your 780 FICO score, you can’t buy that home or finance that business, because the money just isn’t there.

This is not a cry of Wolf. It is not a political ploy. This is the guillotine resting above our nation’s neck, preparing to fall. Congress can stop it, or they can stand idly by as millions of Americans get the “axe,” through no fault of their own.

If banks begin to fail, depositors will grow scared and lose faith in the banking system. We have already seen this, where three month T-Bills were purchased last week with a negative return. Investors accepted a guaranteed loss for the safety of T-Bills. Imagine what might happen when banks begin to fail and depositors begin withdrawing money from banks. This would exacerbate the problem. Bank reserves are being artificially propped by the Fed. This can't go on forever unless the law is changed. This is the task our Congress faces this week. I believe they must fix this. They must fix this fast. They must fix this decisively. If they don't, it will be hard for us to say, "Forgive them, for they know not what they do." Congress has been educated. They have been warned. If they put politics above our nation's safety and survival, they are doing it with full knowledge of the possible consequences.

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