I think I spoke too soon when I extolled the wisdom of the American people last week. Despite having improved upon the Paulson plan they shot it down yesterday. They called and wrote to their congressmen to express their outrage and their congressmen, afraid they would have to get real jobs after the November elections, voted against the plan.

The stock market reacted quickly - to the tune of wiping out $1.2 trillion of wealth in one day. As some commentators have noted this is more than the amount of money being considered for the bailout.

What I find frustrating in all this is the lack of understanding about this bailout package. For instance, people talk as though $700B is the cost of the plan. But it’s not. It’s just the amount of money being put at risk. The cost will be the amount of money lost between what the government pays for the assets and what they can ultimately sell them for. By many accounts the cost will be negative - i.e. the government will actually make money on the deal.

The other bizzare attitude is summed up in the following photo, taken from an article on the Time Magazine site:

As if bailing out a bank is not bailing out the people?

Frederic Mishkin, a former Federal Reserve Board Governor (I took a money markets class from him in business school) had a great story to tell on one of the Sunday talk shows this last weekend.  His grandfather owned a store when the stock market crashed in 1929. His grandfather delighted in the fact that those wall street guys got what they deserved. One year later his grandfather was out of business.

I never thought I would find myself saying this but I actually think that Americans and congress have just demonstrated their intelligence in their reaction to the proposed $700 billion mortgage bailout plan. Maybe it’s just another example of “The Wisdom of Crowds” - the fact that a group of people can arrive at better decisions than a simple average of individual decisions - but I’m impressed with the results of a process that I usually despise. Not that I agree with everything that is being layered onto the plan, but for the most part I think it will actually end up being a better plan after all the obvious posturing is finished.

For starters, like most people, I am outraged that the government has to step in and clean up a mess in the private sector. I love the fact that Lehman died an unnatural death and would love to see even more of the culprits bite the dust. However, I believe Paulson and Bernanke when they tell us that without some intervention we will experience a catastrophe of biblical proportions:

Real wrath of God type stuff.
Fire and brimstone coming down from the skies! Rivers and seas boiling!
Forty years of darkness! Earthquakes, volcanoes…
The dead rising from the grave!
Human sacrifice, dogs and cats living together… mass hysteria!

But do we give them a blank check? Well, the American people and congress have spoken and the answer is No! Here are some of the modifications being sought:

Execute this program on the installment plan, with additional draw downs needing approval. I like this idea, but maybe for different reasons than intended.  No one can know what the real need is but if they give Treasury $700 B then $700 B will be spent. One of my concerns is that the government isn’t merely trying to avoid a depression but they are also trying to avoid a recession. But a recession might actually be healthy for the economy in the long run. So if they have to go back for approval periodically that could discourage them from going overboard.

Take equity stakes in the companies being helped. Seems like a good idea to me. Look at Warren Buffet. He just negotiated a sweet deal with Goldman because he’s the  800 pound gorrilla. Well the US government is the 2000 pound gorilla and should be able to get an even sweeter deal. Besides, this bailout needs to be painful for those who screwed up.

Cap executive compensation within rescued companies. Now normally I would abhor the government influencing executive compensation, regardless of how outrageous it is. But this time it’s different. These companies are taking government money so it can’t be siphoned off into executives’ pockets. Besides, under my pain theory these CEOs need to suffer from their mistakes. There will probably even be a side benefit to a compensation cap. It will prevent CEOs from taking advantage of the taxpayer dollars if they don’t really need the help.

And I’m not the least bit worried about there being a talent shortage because I think these executive types are over-rated anyway. There are a lot of smart people out there waiting in the wings to jump in and take over for $400,000 per year. I don’t subscribe to the view that you have to have a celebrity CEO. In fact, I suspect that the celebrity types are not as smart as the underpaid quiet types. They got us into this mess.

Provide oversight. I have no idea how this would work but in principle it sounds like a good idea.

Helping distressed homeowners. This is the one that concerns me the most. As if this proposal doesn’t already help homeowners by propping up home prices? I’m OK with modifying the bankruptcy laws slightly but what more do they want?

Aside from this last add-on, by and large, the political process seems to be working. The key question that is still up in the air is how to set the purchase price for these assets. That issue alone could make or break this deal for the American taxpayer.

…Happy Days Are Here Again.

Well, that might be a bit of an overstatement but not by much. In reaction to the Fannie and Freddie takeovers bank stocks were up today and so were homebuilders. In fact, Toll Brothers (luxury homebuilder) was up 9.4%, reaching its highest level in more than a year. The reason for all the optimism is that some folks are predicting that mortgage rates will drop by a full percentage point in the next week or so as the governement’s actions reduce the risk of funding mortgages. So this would appear to be good news for the housing market.

Could this be the bottom of the housing market? Not so fast!

The fundamental problem is that all this appears to be the very visible hand of the government interfering with the markets and artificially supporting housing prices. It might work for a while but in the end houses must be priced in accordance with fundamental values. And if prices are being propped up for now then it just means that the day of reckoning has been postponed. Either they will ultimately come down or they will stop moving up until fundamental value catches up with prices.

The US Treasury just announced a plan to place Fannie Mae and Freddie Mac into conservatorship - whatever that means. As explained in the Wall Street Journal the plan “provides as much as $200 billion of new capital plus new credit lines for the country’s main suppliers of funds for home loans … and puts the two companies under management control of their regulator, the Federal Housing Finance Agency, or FHFA.” As part of the plan they are replacing top management of the companies and suspending dividends on the common and preferred stocks. Presumably common stockholders are going to get wiped out. I sure hope this is the case as taxpayer dollars should not be used to benefit stockholders. Besides, I own Fannie Mae puts so I’m hoping the stock goes to zero. We’ll see what the market thinks tomorrow.

This action was absolutely necessary as the mortgage market is becoming paralyzed. However, there is one deeply disturbing aspect of this plan. The WSJ reports that “The Treasury also plans to buy an unspecified amount of mortgage-backed securities issued by Fannie and Freddie in an effort to bring down borrowing costs for home buyers.”

Whoa!!! What’s this? The government is going to further subsidize home purchases? It’s not the place of the government to lower home owenership costs. All this is going to do is slow down the housing market’s adjustment to rational prices. Home prices have at least another 10% to fall, and in the end help solve the housing affordability problem for millions of Americans the right way. Instead taxpayers are going to end up holding the bag on homeowners behaving badly.

Ever wonder why there aren’t corn or soybean fields in The Loop? Probably not. I think you know why. There is a fundamental concept in real estate that dictates that land should always be put to its highest and best use. It make sense, right? Why would you utilize a precious resource in a less than optimal way?

However, there is this 22 acre tract of land in Chicago that has always mystified me. Right on the edge of Lincoln Park, at 2011 N. Southport, 4 miles and 9 minutes from downtown, there is a steel plant. It’s the A. Finkl & Sons Co. factory, complete with scrap metal processing and smelters. (Curiously, they think they are located in the Near North Side.) For the longest time, every time I drove by that place, bounded on the East by really expensive housing, I couldn’t figure out why that place was there. Surely a steel plant is not the highest and best use of that property and surely Chicago could use more housing close to downtown. So I always figured that the Finkl family had some irrational attachment to the steel business.

Well, I have subsequently found out that it’s not the Finkls that are irrational, but actually Mayor Daley. You see, according to this week’s Crain’s Mayor Daley has this campaign to keep manufacturing jobs in the city and has refused to change the industrial zoning of this tract of land, which would raise the value of the land from $29 MM to $80 MM. Hence, $51 MM of economic value is being wasted and this all seems to run counter to the mayor’s other goal of affordable housing.

The article goes on to talk about how Finkl has been threatening to move out of the city entirely if the zoning is not changed and how certain financial subsidies are being discussed. Sounds like more waste to me.

What I don’t understand is what is the magic about manufacturing jobs that the mayor wants to preserve them. All I can say is that it sure is a good thing that the mayor wasn’t around 100 years ago because today Michigan Ave would be lined with liverys and horse drawn buggy shops surrounded by cornfields.