Don’t Forget Detroit’s $25 Billion

"Balkan peasants stealing each other’s sheep."

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"The party’s over. What we are witnessing today is how empires end."

— Pat Buchanan

"This is another fine mess you’ve gotten us into."

— Oliver Hardy to Stan Laurel

For the past two weeks, shocking and stunning the public, the news has been negative and getting worse. But the thing we need to remember about what appears to be a sudden breakdown in the nation’s financial system is that there is absolutely nothing sudden about it. And, even though in three days I’ve read close to 1,000 pages of news stories on what all this crisis entails, then read what the experts think it will take to restore confidence in the market’s operation, I can’t tell you what is real and what is imaginary any more than the top financial experts can. There’s a simple reason for that: They don’t know, either, and that’s what is leading to today’s loss of confidence.

Like Terrorism, But More Costly

The public’s fury at the idea of bailing out Wall Street strongly resembles the rage people expressed after 9/11, and it stems from a similar fear. And, as we all know by now, instilling fear in the population at large is called "terrorism."

Although this latest government bailout package seemed to fail this past Monday, what has already been spent to prop up or sell such renowned Americans institutions as AIG Insurance, Fannie May, Freddie Mac, Merrill Lynch and others, will come to nearly 15 times as much money as was spent to clean up the damage and rebuild in New York after the 9/11 terrorist attacks. The only difference between this disaster and that one is that the masterminds of 9/11 were living in caves in Eastern Afghanistan. The masterminds of the current attacks on our financial system still live in their mansions in Greenwich, Conn.

A key point here is that no one will take responsibility for creating the crisis on Wall Street. Nancy Pelosi told National Public Radio that Congress had absolutely nothing to do with this problem – although in 1999 she voted for the bill that repealed the Glass-Stegall Act of 1930. Repealing that act, which had built a permanent barrier between commercial and investment banks with a view to preventing another Great Depression, is now being called one of the key events driving today’s crisis. But Republican John Boehner voted for it, too: The House’s majority and minority leaders were both in some degree culpable for today’s mess – and both really hoped columnists like me would never check the voting records.

On the other hand, two Congressmen saw the future clearly. In 1999 one rose in the House and delivered this warning, trying vainly to sway the votes of his fellow Representatives: "What we will create if we repeal this act is a group of institutions which are too big to fail. [Italics added] Not only are they going to be big banks, but they are going to be big everything, because they will be in securities and insurance, issue stocks and bonds. Taxpayers will one day be called on to cure the failures we are creating tonight, and it’s going to cost a lot of money, and it is coming our way."

Now, who would have thought that the very liberal John Dingell of Michigan would call this scenario right – or that our own (Republican) Joe Barton would stand up and second Dingell’s opinion?

Don’t Blame the Victims

Yes, this has been coming for years, and I’ve being pointing that out here the best I could. This column’s readers knew that the cost of gasoline, energy and food was running far beyond the modest (published) inflation rate that Washington was bragging was totally under control. Starting in 2000, the average American family tried to meet that hidden inflation with a stagnant income, and consequently our savings rate dipped into negative territory. In many years homeowners were borrowing $800 million against the equity in their homes to break even.

In today’s financial meltdown the most common cause mentioned is all the subprime loans made to homeowners, but that’s just blaming the victims. Moreover, most of those subprime buyers, whose mortgages often exceeded half of their take-home pay, defaulted almost immediately; they were never capable of paying for their new homesteads. My point is that a subprime loan written in late 2004 was in foreclosure by early 2006, and we’re almost three years past that point.

Ignoring the Accurate Indicators

Anyone could have seen this situation going south by watching new car sales; in certain parts of the country their slowdown started in earnest early last year. Yet, though they should know better, economists and Wall Street still love to say that American car sales are "no longer relevant" in determining the health of the nation’s economy. I hope they’re looking now, because we’re seeing that nonsense being proven false, again. Now Detroit says it needs $25 billion in government-backed low interest loans. (Congress approved those loans last year, with the stipulation that the monies had to go to create super-super fuel-efficient automobiles — mileage figures so high that even Honda can’t deliver them on every vehicle it makes. But Congress didn’t allot the $3.5 billion needed to secure that financing, so Detroit considers it time to go back to Congress, rewrite the rules and get the money flowing.)

Likewise, many analysts looked to the Consumer Confidence Index for a sign of what the public was thinking – but they used the "current" confidence numbers. That’s unwise because the "current rate" is incredibly volatile; it can swing wildly in response to rises in the price of things like gasoline.

The experts could have used the extremely accurate survey component that scores how secure buyers feel about their future six months out, instead of the current rate. But that figure hasn’t looked good in years.

Feels Like Financial Waterboarding

Looking for a silver lining, the ongoing slowdown means that there is less demand for certain products that consumers frequently purchase, such as gasoline; and when demand falls and supply is stable, prices generally fall until demand picks back up. But that’s not happening; the futures market has kept oil prices stubbornly high at around $106 a barrel — until the bailout vote on Monday, after which it dropped by almost $11. And that’s odd, considering the Department of Energy’s admission that U.S. oil demand has now dropped by 1.3 million barrels per day.

Moreover, while the $700 billion price tag on the proposed bailout outraged the public, most people don’t realize that both Lehman Brothers and AIG were heavily involved in the oil futures market. Had they been left to fail on their own and been forced to unwind their positions in the oil market, most believe, that would have dropped the price back to $65 a barrel or less. And had that happened, U.S. corporations and consumers would have saved almost $300 billion annually in costs for overpriced oil.

That’s right. Not only will we pay to bail out these companies, but our involvement keeps prices (and profits) for items such as oil, where demand is falling, artificially high.

Worse, I question whether a bailout will even do much good right now. Keep in mind that for every $1 in subprime mortgages written, there was an estimated $3 loaned in Alt-A mortgages. Yes, some were no-documents mortgages, others were interest-only or negative amortization, and they were given primarily to individuals with good to great credit. When someone pens a book on this era 10 years from now, I’d bet it will reveal that the uncertainty over the value of the Alt-A mortgages generated far more problems than the subprime business.

That means we will have more Americans go from being good credit risks to having subprime ratings over the next five years. How many no one knows, but they won’t be getting A Tier credit rates from GMAC anymore.

And Now, The Real World

Now, let’s inject another reality into this equation that everyone is overlooking. The vast majority of homeowners in the U.S. either already owned their current home or didn’t get caught up in the media-led buying frenzy to buy a new home "before they were completely unaffordable." These individuals haven’t lost their jobs or incomes, and they still make their monthly payments on time; and statistics show that that description fits 91 percent of all homeowners in America, not counting those whose homes are paid off. Therefore, if Washington can just remove the fear from the markets, consumer confidence will also slowly return and with it the overall health of our economy. No guarantees, but that statement represents the historical trends under similar circumstances.

As for me, I’ve long been a disciple of Peter Drucker, and he’s right. Wall Street is nothing more than a bunch of Balkan peasants stealing sheep, but those sheep once belonged to you and me.

© 2008 Ed Wallace

Ed Wallace is a recipient of the Gerald R. Loeb Award for business journalism, given by the Anderson School of Business at UCLA, and is a member of the American Historical Society. He reviews new cars every Friday morning at 7:15 on Fox Four’s Good Day, contributes articles to BusinessWeek Online and hosts the talk show, Wheels, 8:00 to 1:00 Saturdays on 570 KLIF. E-mail: wheels570@sbcglobal.net