THE SUB-PRIME MESS GETS MESSIER

I continue to focus on the financial crisis in lieu of my usual tax commentary because of our mutual concern for this problem.

BAIL OUT CHUTES AND LADDERS

1. The Bail Out now resembles the exciting up and down game for children in which players spin the spinner and move pawns square by square. If a pawn lands on a picture square at the bottom of a ladder, the player climbs up with a good deed while naughty deeds slide players back down for landing on a picture square at the top of a chute. Of course, what square one lands on depends on the chance of the spin. So it is with the bail out, the Fed and Treasury are employing tools for managing the money supply and spending but they can’t always foresee all of the consequences of every move. Thus, the bail out plan continues to be adjusted on the fly. The latest adjustments are:

a. The Treasury is for now abandoning the plan to use the remainder of the $700 million fund to buy bad loans held by financial institutions. Instead, it will directly invest more capital into these entities. The Treasury may also later buy some troubled assets but the program proved too problematic to implement wholesale due to problems in determining the price at which to buy and the dispersed ownership of securitized loan packages.

b. As part of the plan the Treasury is now considering requiring recipient banks to raise an equivalent amount of private capital to qualify for a federal investment. Such a requirement, in effect, lets the market determine which banks are worthy of federal aid. The Treasury was concerned that if it continued to invest unilaterally, it would be the government identifying worthy and unworthy banks and causing more stock market instability and depositor flight from those not selected.

c. Last week, Treasury Secretary Henry Paulson announced that the Treasury will shift its focus from unfreezing institutional lending to helping loosen up consumer credit availability. But, he said, “There are no easy answers.”

GRIM NEWS ON WALL STREET AND MAIN STREET

1. The stock market continues to function like a gyroscope that has lost its directional capabilities. GM stock is now trading at its 1946 value and the market as a whole has sunk almost 40 percent from its pre-crisis high.

2. Real estate foreclosures continue at record levels and are expected to increase when the LIBOR rate (dollar London interbank offered rate) adjustments for November that govern many adjustable rate mortgages, take effect. The rate rose for the second straight day on November 14 revering a trend that had been gradually easing credit availability. Many believe that the return of the Treasury to ad hoc steps away from the mapped out troubled asset purchase plan is causing jitters.

3. While economists compare statistics and gross national product measures and argue over which country is technically in a recession, everyone with common sense knows that the world is sailing through turbulent and dangerous economic straits. People are worried about their jobs and security. In the U.S. there is no longer the same safety net in unemployment benefits and public assistance both having been significantly reduced over the last four administrations.

4. The U.S. budget deficit for October climbed to a record level $237.2 billion leaving some to wonder if our resources alone are deep enough to implement the steps necessary to turn the economy around, especially when there is still disagreement about what steps should be implemented and a new administration is on the horizon.

5. Fannie Mae and Freddie Mac are congressionally chartered mortgage companies that buy mortgages from originating banks and repackage them as securities for investors. Recently nationalized by the government, Freddie is now $13.8 billion in the hole. Neither has been able to significantly impact a housing market recovery and their share of the loan market has declined from 70% to 57% due to changing business-models. The business-models are not working because many new borrows are seeking Federal Housing Administration (FHA) loans that are now less difficult to qualify for. The FHA has provided mortgage insurance on loans made by FHA-approved lenders throughout the United States since its creation in 1934. Fannie and Freddie will have to get more money from the Treasury because foreign investors, long major buyers of their debt, are reducing their holdings as the extent of government backing remains uncertain. Funding these companies will put added strain on the bail out program.

6. The U.S. auto industry has its hand out for government assistance. The dilemma facing government is that while GM and Ford account for some 200,000 jobs, their long term viability is in serous doubt. The problems is union contracts that mandate wages, health care and retirement benefits greatly in excess of what foreign competitions like Toyota pay its workers in U.S. plants. The cost structure has led U.S. the U.S. companies to push the short sighted emphasis on trucks and SUVs that have a large profit margin. The industry also has postponed modernization of its plants. Basically, the U.S. companies don’t make money on small cars and small cars are all that is selling now. The question becomes, should government invest in a dead end business model to avoid the pain of job upheaval right now? Unemployment has already risen to 6.5% and is expected to go to 8%.

7. Consumer spending has come to a halt. The Treasury’s desire to stimulate consumer credit is premised on the notion that it is a lack of available credit that is thwarting consumers. It may be more likely that consumers are fearful of losing jobs, of losing their homes, are already saddle with too much debt, and are making a paradigm shift to more frugal behavior. If that is the case, offering more credit will not stimulate spending.

WHAT TO EXPECT NEXT – WHAT TO DO?

1. In short, I wish I knew what will happen next. My crystal ball is cloudy. Congress is reassembling to take up the crisis again for the last time in a lame duck session. President Elect Obama is said to favor helping the auto industry and extending unemployment benefits. But, the viability issue for U.S. auto companies has many opposing aid and others are yet opposed to public assistance they equate with government hand outs. There may be some additional steps authorized but further adjustment and implementation of the plan will occur under the new administration.

2. The dollar remains strong. One’s strategy must be keyed to one’s time horizon. When will you need funds is the prime question? If you will need funds soon, get out of the market and into cash. If many years will intervene before you will need funds for retirement or other expenditures such as college tuition, stay the course adjusting your portfolio for risk tolerance and to reduce exposure in high risk sectors such as finance and auto companies. Pay down debts in any event. Get independent professional advice and don’t take action based on generalizations printed in the newspaper or heard at cocktail parties.

3. If your business is in distress, do not stop depositing payroll taxes withheld from your employee’s wages. The IRS is particularly ruthless in collecting trust fund taxes as they are called. You can be held personally liable for the full amount withheld and not deposited. These taxes are not dischargeable in bankruptcy. The IRS is the worst creditor to have on your back especially for withheld payroll taxes not deposited.

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