Sep 9, 2008

Kevin Duffy on the Henry Paulson led government takeover of Fan/Fred

It's official: The U.S. economy is headed for its worst recession in three decades. Henry Paulson's scheme to keep Fannie Mae and Freddie Mac on government life support and bail out its creditors (i.e. Wall Street, Big Banks, and Bill Gross at PIMCO) removes any doubt. The only question remaining: Will this downturn rival the Big Kahuna of the 1930s? Paulson was interviewed today on Bloomberg. Here is the money quote:
“No one likes to put the taxpayer into situations like this. No one does; I certainly don't. Government intervention is not something I came down here wanting to espouse, but it sure is better than the alternative.”
The alternative, of course, is that Paulson’s friends are actually forced to take huge losses on their reckless, ill-fated loans to Fannie and Freddie. Unthinkable! Paulson assures the naïve interviewer that the taxpayer will come before the shareholder, forgetting to mention the shareholder has already been wiped out, putting the taxpayer last in line behind the creditors. Under Hanky Pank’s scheme, the taxpayer is simply the bagholder of last resort. Paulson was obviously a quick study under former Goldman Sachs CEO and Treasury Secretary, “Mr. Bailout” himself, Robert Rubin.

The initial reaction of the stock market was to celebrate with a 300 point rally in the DJIA. Our guess is the euphoria will fade quickly as investors realize bailout money does not grow on trees, and the cash will either be taxed, borrowed or printed. The only question: How much will the final tab run?

The more pressing concern, however, is the economy. This economy needs to break its addiction to cheap credit, remove the waste of the previous credit binge, shed its political parasites (e.g., friends of Hank), and rebuild on a solid foundation. Every intervention prolongs the process and deepens the malaise. A wholesale government takeover of the mortgage market virtually guarantees the economy will be mired in deep recession for years.

The only winners (besides whiners like Bill Gross)? Those who are short the market.

Note to self: Move those inflation hedges from the attic to the front hall closet.

~ Kevin Duffy, Bearing Asset Management, "Paulson's gift to the bears," Azimuth blog, September 8, 2008

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