Today is the Labor Day holiday in the USA, so to honor the more vulnerable parts of our society and economy I’m engaging in this fantasy rethinking of our current economic crisis.  If only……

When the “unsinkable” ship Titanic hit an iceberg and sank on its maiden voyage in 1911, as any teenage girl will tell you, the rich people got nearly all the lifeboats (except for John Jacob Astor IV who ordered another drink, giving up his seat), dooming the lower-class passengers including, of course, poor Leonardo DiCaprio. Much the same thing seems to be happening in the case of the current economic crisis, where the people who are hurting the most seem to be getting the least.  I’m beginning to believe the crisis could have been fixed quicker and cheaper simply by helping the women and children instead of the bankers.

This began as a mortgage crisis.  Lenders dropped their standards on loans, giving them to people who shouldn’t have qualified (yes, they applied for those loans so are also culpable), driving housing prices up in a bubble that eventually popped and here we are with eight percent of all mortgaged houses in foreclosure and home prices down 30-40 percent from two years ago.  The technique our government used to deal with this was to prop-up the bankers, not the borrowers.

Why?

That’s a question I have been asking all over and the smart money answer generally comes down to: 1) that’s the way the system is set-up; 2) that’s the way we’ve always done it, and; 3) it would be too complex to deal with individuals — better to deal, instead, with a few dozen banks.

Why?

The system was widely perverted to deal with the current crisis; it wasn’t “business as usual” at all.  Companies that weren’t (and still aren’t) bank holding companies were declared to be so and got money from the Fed and Treasury as a result.  Same for insurance companies and brokerage firms and car companies that remained as they were but got money still from the Congress or through sleight-of-hand by Fed chairman Bernanke.

Doing things “the way we’ve always done it” is what got us into this mess.

And the miracle of information technology makes it just as easy to send money to people as it is to take it from them in the form of taxes.  Saying that a bank has to be in the middle makes no sense at all. PayPal would gladly assume that function, if it is truly needed.

I’m beginning to realize we could have taken a completely different approach to the problem and simply treated the symptom, inserting what computer jocks call a “wait state” into the mortgage system so panic could subside, rational adjustments could be made, and life could be eased back to normal.

Remember that economies are cyclical and a lot of good financial planning is simply having enough reserves to survive until things get better.  That could have been our major economic tactic in dealing with the crisis in 2008. Instead of pumping $700 billion to $1.3 trillion (nobody knows the real number) into economic stimulus and bail-outs, the U.S. government could have simply paid everyone’s mortgage — EVERYONE’S — for six months.

There are 51 million mortgages in America and the average mortgage payment in 2006 was $1686, so paying everyone’s mortgage for six months would have cost $516 billion — hundreds of billions less than the Bush/Paulson/Obama/Geithner/Bernanke plan, and quicker, too.

The money that people would otherwise have used to make their mortgage payments could have gone in part for other things, making it effectively a huge economic stimulus in its own right.  With mortgages paid in full there would have been no foreclosures OR bank failures during that six month period.  Yes, there would still have been problems with the banking system that needed  correction, but there would have been six months to do the correcting.

Lehman Brothers would still be in business, Bear Stearns, too.  Merrill Lynch would be independent. AIG would not have failed. Even Bernie Madoff would probably still be in business — at least for awhile.

So why didn’t we do it that way?  Because it would have been putting women and children first.

I need a drink.

Podcast: Play in new window | Download

When Barack Obama was running for President one of his favorite sound bites was that any financial bailout should not just involve Wall Street, but Main Street, too – that the government’s responsibility was to help both bankers and homeowners. But now that the election is won and Obama is in office, the two streets are still being treated very differently, with Main Street getting a lot less help from Washington.

This is a HOUSING crisis, not a BANKING crisis, yet $700+ billion has gone to help bankers and only $75 billion to “help” homeowners. The banker’s money has mainly been spent and the homeowner money has hardly been touched. If this is a HOUSING crisis, why aren’t more resources being devoted to housing?

It comes down to an issue of morality, believe it or not, with homeowners expected to be moral and bankers not. Everybody blew it, but the homeowners are being disproportionately punished for their actions.

There is no morality issue in the bank bailout. Banks are having their capital boosted based not on whether they are well run or in some way “deserving,” but purely on the basis of whether they are viewed as being in three groups: 1) doomed; 2) capable of being saved through injecting government funds, or; 3) too big to be allowed to fail no matter how poorly run. This means the least-deserving banks tend to get the most help.

But the Obama Administration’s attempt to help mortgage holders is different. If you hope for government help in restructuring your mortgage you’d better not be behind in your payments. If you missed a mortgage payment months into this crisis, you are out of luck. If your mortgage isn’t guaranteed by Fannie Mae or Freddie Mac, you are out of luck. If your mortgage is jumbo you are out of luck. And if you owe more than 105 percent of the value of your home you are out of luck.

That’s a lot of homeowners out of luck. No wonder the Obama Administration thinks it needs only $75 billion to do the job, it is excluding so many people.

Let’s try applying the homeowner rules to the banks. If both played by the same rules, then banks with mortgage portfolios that have dropped by more than about 15 percent (are five percent or more underwater) would be ineligible for government assistance. Banks that MADE jumbo loans would be ineligible for assistance. Banks that made loans with private insurance or no insurance would be ineligible for assistance. Banks that had shown themselves unable to meet capital requirements (had effectively missed a payment) would be ineligible for assistance. In each case, these criteria define EVERY bank that has received assistance. They ALL have mortgage portfolios down in value by 15 percent or more, ALL made jumbo loans, ALL made uninsured loans, and ALL are under capitalized.

So if we apply to banks the same rules that are being applied to homeowners, then no banks deserve support and there should be no bank bailout. Well that can’t be, can it? So screw the rules, screw the idea of there being a moral issue with bankers, just start handing out cash without even requiring that they use any of it to make or restructure loans.

So that’s what the Treasury and the Fed have done – bailed out the bankers without regard to their past OR FUTURE behavior. And $700+ billion later do we really truly feel better as a result?

Hell no we don’t, because we still can’t pay our mortgages!

This bailout is broken, it is unfair, and it is incredibly inefficient as a result. The bank bailout is based entirely on providing INCENTIVES to the banks – bribing them to THINK ABOUT doing the right thing.The government won’t MAKE the banks do anything. They just ENCOURAGE the banks by giving money.

Where are the incentives in the much smaller housing bailout? There are incentives. THEY ARE ALL BEING GIVEN TO THE BANKS. It is very difficult to find in the new Federal mortgage modification rules much of anything that truly helps homeowners. Banks aren’t REQUIRED to do anything; they can reject any mortgage holder for any financial reason. The banks are PAID to restructure the mortgages and the way those mortgages are being restructured (primarily through increasing term and adding balloon payments) not only costs the banks nothing, it tends to make them MORE money over the life of the loan.

So that $75 billion allocated to modifying mortgages and keeping people in their homes, how much of that $75 billion will actually go to homeowners? About 25 percent, or $18 billion almost entirely in first-time buyer tax credits. This means the bank bailout isn’t $700+ billion, it is $758+ billion or FORTY-TWO TIMES the size of the housing bailout.

And why only first-time buyers? What makes them more deserving of help? The theory is that these are new homeowners so they’ll be buying-up excess inventory and helping to firm prices. They aren’t people selling one house to buy another. In another view they are virginal and uncorrupted by the housing bubble.It wasn’t their fault, so they are being rewarded. More morality, inequitably applied.

Main Street isn’t doing very well under this policy. Main Street is being cheated.

This is a bad plan, unfair and poorly executed. It places a moral burden on individuals and not on banks, yet there is no good explanation for why it has to be so.

What is it about banks that make them deserving of 42 times as much support as your Mom?

Nothing.

Like the Bush Administration before it, the Obama Administration has a bias for helping Wall Street. They couch this as a claimed inability to come up with any better ideas. Yet better ideas – ideas NOT couched in moral argument (or more appropriately couched in EQUAL moral justification) were presented right in this spot in the post titled The Not So Bad Bank. That’s a plan that helps banks and homeowners equally, doesn’t require incentives to work, acts faster, and costs a tenth as much.

What’s wrong with doing the job better, faster, and cheaper?

Podcast: Play in new window | Download

This post first ran on January 29th on my mortgage blog.  It got some traction there and  a  few mentions in the press so, lazy bastard that I am, I’m reproducing it here in a slightly improved form that corrects my own math error.

Take a look at this chart that someone sent to me a couple days ago.  I’m making it big so you can see as much detail as possible.  Have a look and then come back, okay?

Pretty scary, eh?  It’s a chart showing the deterioration of major bank market caps since 2007.  Prepared by someone at JP Morgan based on data from Bloomberg, this chart flashed across Wall Street and the financial world a few days ago, filling thousands of e-mail in boxes.  Putting a face on the current banking crisis it really brought home to many people on Wall Street the critical position the financial industry finds itself in.

Too bad the chart is wrong.

It’s a simple error, really.  The bubbles are two-dimensional so they imply that the way to see change is by comparing AREAS of the bubbles.  But if you look at the numbers themselves you can see that’s not the case.

Take CitiGroup, for example.  The CITI market cap dropped from $255 billion to $19 billion — a difference of 13.4X.  If we’re really comparing the areas of the bubbles, that means 13.4 of those tiny CitiGroup-of-today bubbles should precisely fill the big CitiGroup-of-the-good-old-days bubble.  Only they won’t.  As a matter of fact it would take about 13.4 times as many little bubbles to fill the big bubble as the chart preparer thought or 179.64 little bubbles.  Pi r squared, remember?  This is because the intended comparison wasn’t two-dimensional but one-dimensional — the chart maker was intending we compare the DIAMETERS of the bubbles, not their areas.

So it’s a typo: no big deal, right?  Yeah, but what a typo!  It got past Bloomberg and JP Morgan and pretty much all of Wall Street before someone said, “Hey, this makes no sense!”

And who was that someone? Me!  A nobody.  Or at least someone unimportant enough not to be asking for a Federal bailout.

How could this be?  It’s because Wall Street doesn’t work the way we think it does — the way we are led to believe it does.  Wall Street is a marketplace, a selling ground where everything from ideas to stocks and bonds are on sale every day.  And there is nobody easier to sell to than a salesman. Come up with a good chart that’s ALMOST within an order of magnitude of reality, put a disclaimer on the bottom, and let ‘er rip.

No wonder we’re in a global financial crisis.

The people we count on to understand what’s going on can’t even read a chart.

Podcast: Play in new window | Download

Microsoft announced this week its first-ever layoffs, which brought out the naysayers and predictors of doom, but not me.  I see cutting these 5000 jobs as good, with my only caution being that it really should be 20,000 at least. Fifty thousand would be better.

I am not, nor have I ever been, a big fan of Microsoft.  Lots of smart people at Microsoft do great work and lots of other people at Microsoft do not do great work.  It would be nice if most of the 5000 being let go were the latter variety, but who really knows?

This is a complex subject so I am going to take it one piece at a time.  First there is the issue of Microsoft having never before had a layoff.  In one sense why would they?  The company makes so darned much money – or at least they have historically – that layoffs in the traditional sense of cutting fixed costs have hardly been necessary.  But there is a problem with not having layoffs and that’s the sad fact that it makes it difficult to get rid of people who simply don’t belong.  There are a lot of folks at Microsoft who should have departed long ago, but why?  It’s comfortable in a way, the benefits are good, and once you’ve been around for a few years, heck, there’s not much they could ever do to get rid of you.  There are people – possibly thousands of people – coasting at Microsoft because of the company’s policy of simply allowing it.

Next let’s consider how big a layoff this really is – 1400 people right away and up to 5000 by sometime in 2010.  Microsoft has, depending on how you count it, about 100,000 employees.  If the average time in service is 10 years that implies that 10 percent of the Microsoft workforce leaves every year, which feels about right.  That’s 10,000 folks leaving of their own accord EVERY YEAR.  So what does this layoff mean, anyway?  “Over the next two years we’ll be eliminating 5000 positions.”  It means nothing.

The company’s intent MIGHT BE to permanently eliminate 5000 jobs over two years, but all that would mean under this scenario is that their hiring during that period would be limited to 15,000 replacements.

The real problem at Microsoft is one that every other public company would love to have – they make too much profit.  So unlike every other public company, Microsoft traditionally manages its earnings not by cutting expenses but by increasing spending.  It’s a legacy technique invented years ago by legendary CFO Frank Gaudette and embraced by Bill Gates and Jon Shirley because it accomplished the task of meeting Wall Street expectations, allowed the company to hide spectacular true profit margins, while still generally keeping anti-trust officials off Microsoft’s back.

The problem at Microsoft typically hasn’t been, “Oops, we’re not going to make enough money this quarter; how do we boost earnings?” It has been, “Oops, we’re going to beat Wall Street estimates by too much; what can we spend money on to bring our numbers into proper alignment?”

It’s a great problem for a CFO to have.

But what happens, then, when you finally do have a bad quarter?  For Microsoft it triggers a number of interconnected decisions and events.  If it were run like a normal company Microsoft could simply cut a bunch of expenses, move some money around and – like IBM does right now – look terrific to Wall Street.  But Microsoft doesn’t want to do that for a number of reasons, most of them familiar to erstwhile Y2K vigilantes who hid in the mountains in late 1999 waiting for the end of the world.  Simply put, Microsoft’s current system has built into it about $100 BILLION in hidden financial resources in the form of accounting rules that could be changed and whole businesses that could be jettisoned or even sold.  But having spent all these years building up that fat in case it might eventually be needed, Microsoft is loathe to make the changes required to start burning that fat in fears that the whole technique will be compromised and the fat burned before it is truly needed.

So they leave things pretty much as-is, announce a first-ever layoff that’s as close to meaningless as possible, and cut a few expenses to generate a projected $1.5 billion savings.  Why not?  We’re in the worst economy of our lives.  Making ONLY $4 billion in profit last quarter will be quickly forgiven.

I’m not saying here that Microsoft has fudged any numbers.  Just the opposite, I’m saying that for maybe the first or second time ever they AREN’T fudging numbers.

Microsoft is in trouble.  While they don’t this year need any of the doomsday techniques they’ve carefully built into the system, eventually they will.  Its simply inevitable as the world goes more and more mobile and Microsoft can’t control a majority of that mobile business.  It’s not that the PC is dying but that it is being supplanted – supplnated by platforms and business models that Microsoft does not control.

Anything less than majority market share in every segment means Microsoft is losing and losing big.

Steve Ballmer doesn’t appear to have any sense what to do about this and should leave the company.  Certainly the “beat Google” war is already over and Microsoft lost, whether Ballmer knows it or not.  Google, too, will fail in time, but not to Microsoft.

Redmond can continue to own the desktop but what happens when desktops disappear?  The company will eventually start whittling itself down, earnings will continue to look good, Wall Street will continue to be impressed (sort of) but it won’t make any difference at all to the endgame, which is oblivion or — worse still — irrelevance.

Instead of 5000 positions, the company should drop 50,000.  It should decide what businesses it is in and close or sell the rest.  It should be a lot better than it is at running its true core – the muscle that’s been hiding beneath all that fat.

The big question is whether Microsoft will do it, or even CAN do it?

I have my doubts, one of which is that it even matters.