Bailout benefits

By DAVID MOON, Moon Capital Management, LLC
October 12, 2008


You know about the 'housekeeping items' (that is, bargaining chips) added to the rescue (previously 'bailout') bill: The tax breaks for people who ride their bicycles to work. Subsidies for manufacturers of children's wooden arrows.

You're in a small minority if you didn't get your own personal earmark. It took an extra week ' and an extra $150 billion dollars in political payoffs ' to get enough politicians on board, but it is done.

It is a terrible bill. The people who voted for it should be ashamed. The only thing worse than voting for the bill would have been not voting for it.

Of two terrible choices, the bill is less terrible than no bill.

This is difficult to understand.

The total amount of mortgages in the U.S. is estimated to be about $12 trillion. Subprime mortgages total about $1.2 trillion. Since only 35% of subprime mortgages are in default, you could bailout the entire defaulted subprime mortgage market for only $420 billion.

But it's more complicated than that. It has become more than a mortgage issue. It's about all sorts of credit. Here's an example.

Connecticut-based CommonFund offers a short-term investment pool to universities and colleges. Interestingly, the trustee is Wachovia, although that bank's problems have nothing to do with this fund's problems.

Colleges have become concerned about their investments in the fund and increased their requests for redemptions. The problem, however, is that the fund owns some bonds that no one is willing to buy ' even though those bonds aren't likely to default. Without being able to sell those bonds, the fund can't create enough cash to meet the redemption requests from the colleges.

Also as a result, the fund has restricted withdrawal rights, and isn't going to allow investors to have all of their money until 2011. Remember, these schools were using this fund like a money-market fund. They thought they could get their money each day. But now some universities are struggling to find the cash to make their payrolls and meet other operating expenses. This is happening because no one wants to buy some of the securities owned by this fund.

If the fund could hold the securities until maturity, it probably wouldn't lose a nickel.

Baseball great and syntax-challenged philosopher Yogi Berra once said that if people don't want to go to the ballpark, no one can stop them. That describes today's credit market.

Paying off every mortgage in the country wouldn't solve this problem. Investors are simply unwilling to extend certain types of trust in this market. No one can make investors buy securities if they don't want to.

The federal government is in a unique position to help in this situation. It can buy securities like those owned by CommonFund, providing the liquidity the fund needs for its investors.

Is this a bureaucratic bailout of much of big Wall Street? Probably.

Is it the greatest development in the history of the children's wooden arrow industry? Absolutely.

But it is also much more ' and some of it positive.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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