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Stock Ideas Investors Daily Edge “PayGo” Rules instituted by Congress
Stock Ideas Investors Daily Edge “PayGo” Rules instituted by Congress 
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| “PayGo” Rules instituted by Congress |
| Friday, 26 September 2008 | ||||||||
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The U.S. government is planning to spend more money to shore up the financial system than has been spent in the entire Iraq War, so far. $700 billion for a fund to buy bad mortgage related assets. That doesn’t include another $400 billion to backstop money market accounts. Oh, and let’s not forget that $170 billion ‘stimulus’ package passed earlier this year, the $85 billion for AIG, the $30 billion to bailout Bear Stearns, or the $202 billion to bailout Fannie and Freddie. That’s $1.587 trillion in proposed spending this year alone. Put another way, that’s approximately $15,000 per household in the United States. In other words, Congress is spending roughly the amount it would take each household to buy a decent used car, or even a fuel-efficient new one. Let’s set aside the debate as to whether the U.S. should have even made these bailouts. That’s a hot topic, for sure. Instead, let’s ask the seemingly logical question as to whether this nation could truly afford another $1.587 trillion in spending. The first thing I want to know is what ever happened to the “PayGo” rules instituted by Congress recently. Under those rules, any new spending should be offset with spending cuts. But what the hell do you cut in order to save $1.587 TRILLION in a single year? This is a 57 percent increase in U.S. spending from last year. It doesn’t matter how many other budget cuts you find. There’s no way the budget can be cut enough to offset that type of spending increase.
Well, I suppose it could, but it would amount to cutting US Spending in all agencies by about 60 percent. That just won’t happen. So it’s no mystery that the “fiscal discipline” talked about by both Republicans and Democrats went right out the window. I guess they have an excuse. The excuse is that in the end, most of this spending will come right back to the US. For example, that $85 billion loaned out to AIG was done at an 11% interest rate. Now, AIG is a very strong company. They have more than enough assets to cover $85 billion, and that’s the first thing they will do – pay that debt back. Once that happens, the government gets its money while collecting 11 percent. Not only that, but that 79 percent stake they bought in the company will be sold off, probably at a premium (because once AIG can pay off the government loan, the business will be looked upon more favorably by the market). In this case, it will take some time, but the government should make out like a bandit. And the truth is, the government should do well with the $700 billion bailout package too. Of course, the devil is in the details. If the U.S. can buy these assets cheap enough, it’s almost guaranteed that in a few years they’ll be able to sell them at a premium. At the very least, the government could hold these assets until maturity. As long as they mature higher than what the government paid, the government will make out. I can’t imagine the government buying these assets for more than fifty cents on the dollar. At this time, it doesn’t look like these assets will mature at a value that low. Another proposition is to have banks exposed to the risk of losses just in case the fund does end up losing money. And some lawmakers want to limit executive pay of any bank that decides to take part in this fund (great idea!). Truthfully, I think the government is going to make out really well on this deal, but on the flipside, we’re now being saddled with $1.587 trillion in additional spending. It’s a risk being placed on the taxpayer to bail out the wealthy, and it won’t be paid back for years and years. It’s a risk I’d rather not have, but by the same token, I’d hate to see what “Great Depression” like conditions would do to a lot of unprepared people in this world. What’s certain is that this additional spending will constrict the next administration. And both candidates have ambitious spending plans. Higher taxes are almost guaranteed for high-income earners. Expect them and get comfortable with them. And expect a few more years of lackluster growth. To put this into perspective, the last time a fund was considered to help banks get rid of junk assets was the Resolution Trust Corporation in 1989. Yet, it still took one year for the stock market to bottom, two years for the economy to bottom, and three years for the housing market to bottom. While this proposed $700 billion fund should help the economy, it won’t work like magic. It could take a year before banks stop working on their own problems and begin lending again. After that, it might take another year or two for the effects of that lending to really hit the market. Just remember, market rallies are built on solid earnings and fundamentals. At this time, we have neither. Expect the market to rally lightly and then continue on another leg down. Especially once the ban on short selling expires (and earnings come the following week). Stay free, Charles P.S. To let me know what you thought of today's article, send an e-mail to: This e-mail address is being protected from spam bots, you need JavaScript enabled to view it
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