Politicians sink rescue plan

Pigheadedness and politicking cost American taxpayers $1.1 trillion from their savings and retirement funds yesterday, according to Datamonitor. What seemed like a certainty only yesterday became the unthinkable last night, as the US Congress voted down the Emergency Economic Rescue Act of 2008. The reaction was immediate and violent. The New York Stock Exchange plunged into a tailspin, wiping a billion dollars off the value of its companies. Asian markets reacted negatively too, adding to days of mounting bad news.

As the credit squeeze claimed its latest victims, governments on both sides of the Atlantic stepped in with fixes to patch an increasingly weak system. Over the weekend the UK government took over Bradford & Bingley, selling its savings business to Banco Sandander for £612 million ($1.1 billion). The building society, which was a major player in the buy-to-let and self-certification mortgage market, saw delinquencies rise and its access to funding dry up. And elsewhere in Europe the Dutch, Belgian and Luxembourg governments stepped in to bail out Fortis, taking a 49% equity stake and requiring the sale of ABN Amro's operations in return for €11.2 billion ($16.4 billion) in funds to shore up the beleaguered company. Last night Belgium, France and Luxembourg injected €6.4 billion ($9.2 billion) into Dexia to shore up its business, and in Iceland the government took over the country's third largest bank, Glitnir, buying a 75% stake for €600 million ($878 million) to prevent what the Central Bank chairman said would be its collapse.

Meanwhile in the United States Citigroup will buy Wachovia's operations for $2.1 billion in stock, and will assume $53 billion in Wachovia's debt, but only with FDIC support; the agency will provide loss protection in connection with around $312 billion of “mortgage-related and other Wachovia assets”. The deal comes on the heels of the collapse of Washington Mutual, seized by the FDIC and stripped of its assets, which were sold to JP Morgan for $1.9 billion.

In fact it may be the regional banks, and the communities they serve, that see the worst of this fallout. Banks like National City Corp, for example, with 1,400 branches across six states, 32,000 employees and 634 million shares outstanding, saw its market capitalization slide 63% yesterday, to $1.36 from a high of $26 a year ago.

Leaders? What leaders?

In Datamonitor's view these measures by governments and solvent banks are simply plasters on an increasingly ill patient. The system is broken, and requires a major operation to fix. Unfortunately America's politicians failed to convince Main Street of the impact that dragging their feet or worse, doing nothing, will have on their futures. With five weeks to go before their re-election, not enough elected officials were willing to take their role as “leaders” seriously enough to educate their constituencies about the cost of failing to act decisively. Datamonitor has calculated that cost given the following facts:

1. American households hold $4.9 trillion directly in equities and the same amount in mutual funds;
2. 58% of these mutual funds' assets under management are invested in equity funds;
3. Americans additionally hold $5.6 trillion of their retirement funds in mutual funds, $3.9 trillion of which is invested in the stock market.

Thus, regular Americans hold around $11.6 trillion in equity investments, 9.5% of which was wiped off the Dow Jones industrial average (DJIA) yesterday in response to lawmakers' failure to pass the Emergency Economic Stabilization Act. The American people probably lost $1.1 trillion of the value of their investment accounts and retirement funds as a result. This loss compounds the 21.5% decline that the DJIA experienced up to yesterday morning, and translates into up to $3.6 trillion wiped from the value of their equity-related investments since last October.

Initial costs, with later payback

The proposed plan would have cost each taxpayer around $5,000 in initial outlay, with proceeds on the eventual sale of the assets flowing back into the coffers for the benefit of taxpayers. Yesterday's “Wall Street” crash, which seemed distant to many Americans, cost each taxpayer $5,000 from their investment and pension accounts. Incidentally, today is quarter-end, when millions of investment statements will be generated. By the weekend the taxpayer will see the impact of their elected representatives' grandstanding translated into stark black and white.

Of course the cost to the rest of the world's economies is much bigger than individuals' negative investment returns. After all, the root of the problem is illiquidity as banks hoard cash. Unless and until they start lending again, to each other and to households, the global financial system cannot recover. The result is increased unemployment as companies fail to get the capital they need to grow, or even stay in business, and hundreds of banks fail. It is also continued devaluation of property and declines in investment returns, including those currently building up the baby boom generation's retirement nest egg.

It remains to be seen whether any law that does pass is strong enough to unclog the lending markets after the compromises that will be necessary to convince the naysayers to vote for it. “In the meantime,” notes Michele Gorman, Lead Analyst for Wealth and Asset Management for Datamonitor, “uncertainty about who'll fail next is making the world's investors desperately search not for a return on their investment, but for a return of their investment.”