Bailout May Bring More Economic Disaster If Obama Doesn't Act

September 22, 2008

By Daniel Bruno Sanz

Perhaps the reader will think it presumptuous of me to proclaim Obama the winner before the first vote has been cast and arrogant of me to contradict our financial high priests Hank Paulson and Ben Bernanke, the successor to Alan Greenspan. They have declared that we are on the edge of the abyss and their prescriptions must be followed to avoid certain economic collapse. Democrats Chuck Schumer and Barney Frank tell the press that there was no alternative to granting Paulson and President Bush astonishing powers over government deficits, spending, taxation, the budget and with them the national agenda for the next eight years and more.

Let us assume that deteriorating economic indicators boost the opposition party at election time. Even before last week's market meltdown, McCain's prospects were already dim. Here's why: Joblessness is on the rise in all 12 battleground states with Michigan leading the way at 8.9%. In Florida unemployment has surged by over 50% to 6.5% since August, 2007. Nationwide, unemployment has hit a 5 year high of 6.1% and rose in no less than 44 states overall. The Labor Department has reported that out of a dozen swing states, 11 had a "significant" increase in joblessness over the last 12 months. In the key swing states of Florida, Virginia, North Carolina ( 6.9%) , Colorado and Nevada unemployment is up by over 40%. Michigan, Missouri, Nevada, New Hampshire, New Mexico, Ohio and Pennsylvania have also seen heavy increases. These 12 states account for 157 of the 270 electoral college votes needed to win the White House. In Missouri, which has voted for every presidential winner except one since 1900, unemployment is up to 6.6% from 5.2% last August. Nationwide unemployment claims now exceed 3.45 million, a 25 year high.

But there's more bad news: Florida, Nevada and California have the highest foreclosure rates nationwide. California, the electoral prize of prizes, already leans Democratic and Florida has 27 electoral college votes, more than any other swing state. The Wells Fargo Home Refinance Index is in deep recession territory.

So what does any of this have to do with Obama becoming president in a "close" election? Isn't the real issue his skin color and whether angry female Hillaryites will seek revenge by voting for McCain/Palin? Isn't the burning issue lipstick on a pig? For an answer to this question, I invite the reader to examine "Why Obama Will Win in 2008 & 2012" at www.WhytheDemocratswillwinin2008.com

What we have seen this past week is a paradigm shift in the economy of the United States that will have a frightening impact on our future. Fannie, Freddie and AIG have been nationalized and with them two thousand thousand million dollars in debt of unknowable value transferred to the government's balance sheet. On September 19 the government promised to transfer another 700 thousand million dollars in toxic debt ( debt instruments worth far less than par that nobody wants) from both domestic and foreign bank ledgers to its own liabilities, causing bank stocks to soar while Lehman Brothers, now extinct, was removed from the DOW average. This is why the DOW rallied 700 points this past Thursday and Friday. Meanwhile on September 17, Americans, in a panic, pulled 89 thousand million dollars of their savings out of money market funds in what may be the beginning of a run on the banks. In response, Treasury has promised 400 thousand million dollars to support the money markets.

The government (taxpayer) infusion of massive financial waste into its portfolio is the socialization (spreading out) of risk and loss while profit and reward remain in private hands. Its Adam Smith's invisible hand when stocks are up and the heavy hand of Socialism when losses threaten to wreck the system. Deregulation, Milton Freedman and his Chicago School, Reaganomics, George W. Bush and John McCain are in the ash heap. Without getting too technical with a lot of dismal economic theories and graphs, let me cut to the chase. Here are the consequences of this past week :

The bank bailout will be (rightly) seen as grossly unfair by voters who will vent their anger at the incumbent party ( Republican), which is also the party most identified with high finance and therefore the most culpable. This puts John McCain at yet further disadvantage on November 4.

In early 2009 president Obama and the Congress will pass sweeping new regulation of the financial industry, bring Glass-Steagall back and otherwise please the voters but it will be too little too late.

The US dollar will now be the world's first currency backed by junk bonds, i.e. Mortgage Backed Securities, Credit Default Swaps and shaky car loans. Devaluation must follow unless Bernanke is a magician.

Waves of Adjustable Rate Mortgages and Option Arms are due to reset higher through 2010, adding fuel to the foreclosure fire. Housing prices must deflate further. The irony is that homelessness will increase.

This month's closed door, weekend meetings between Paulson, Bernanke and other un-elected personalities have effectively set America's fiscal policies for the next eight years and more. A 2009 tax increase of 44% and a spending cut of 20% will be required with no visible benefit to the taxpayer. Universal healthcare will be shelved while the unfounded liabilities of Social Security and Medicare go unresolved, creating an unmanageable fiscal crisis that could require the suspension of four thousand thousand million dollars ( that's 4 trillion) in benefits to78 million baby boomers set to retire over the next ten years, forcing many into poverty. Any reform agenda Obama and the Democrats had will become a distant dream as they attempt to contain the crisis they inherited. ( The Democrats' hands in creating the mess are not clean either.)

US sovereign debt may be downgraded, something unthinkable until now. The US dollar, already down by nearly 50% on George Bush's watch, will resemble the Mexican peso. Foreign central banks will continue to diversify ( that's banker's lingo for dump) out of the dollar as it becomes clear that the United States government is unable to pay its debts. Digital dollars created out of thin air will no longer be wanted. That's when the United States ceases to be a super power and becomes a second rate nation in hock to the banks of Japan, China and others. Its military superiority can no longer be financed. Asian creditors get left holding the big bag of devalued American paper. They are not amused.

Long term US interest rates will skyrocket and double digit inflation not seen since the 70s will return. Real wages will fall, the union movement will be invigorated and Americans' living standard will plummet, causing a political crisis that will be laid at Obama's feet.

I have not even touched upon the unsustainable current account deficit, another kind of cancer altogether.

Finally, this panic has not run its course. Markets will plunge again in the next few hours, days and weeks leading into October, 2008. There will be yet another recovery before election day as the Arab oil sheiks use all their financial might to support US stocks and the US dollar while depressing oil prices to help McCain claim victory. But it won't work.

What is President Obama to do?

I don't presume to be smarter than Ben Bernanke, the renowned Princeton scholar on the Great Depression. But I do think that political choices are now being made to best serve the elites who most benefited during the bubble years. Speculators are bailed out while homeowners are left underwater with their mortgages. Their debt is not forgiven and their payments will not decrease. Paulson, whose Goldman Sach's stock was worth 500 million dollars when he cashed out and become Treasury Secretary, tells us we must save the banks at any cost. I say country first, banks second.

Here, at first blush, is my solution: Publicly go along with Paulson's plan for now. Do everything possible to reassure the banks their money is safe.

Quietly create a new banking institution free of toxic debt. Avoid counterparty transactions with banks that hold ( held) such debt. Prohibit trading of derivatives of Mortgage Backed Securities.

Repeal the bailout in 2009. Shift bad debt off the government balance sheet back to the banks it came from and let the chips fall where they may. Banks will be ruined and fortunes lost. The stock market will crash.

Slowly write down the mortgage principal on the ruined banks' balance sheets. Apply mortgage payments to principal first, interest and fees last. Homeowners keep their homes and build equity quickly. Housing deflation is checked. The dollar is saved. Economic recovery follows.

Of course, I have not considered all the ramifications. But the bottom line is that the current bailout will bring about the ruin of the United States and does not keep people in their homes. As Commander in Chief, Barack Obama can not allow this to happen.

Daniel Bruno Sanz is a currencies trader and the author of "Why Obama Will Win in 2008 & 2012." FOR MORE INSIGHTS FROM THIS FELLOW'S BRILLIANT WEBSITE, CLICK HERE: www.WhytheDemocratswillwinin2008.com