Editorial: Toil and trouble (September 24, 2008)

The week ended Sept. 20, the 38th trading week of 2008, was one for the financial history books.

Even veteran market participants have been taken aback by the swift collapse of the U.S. subprime mortgage business, the volatility it’s created in the global markets, and the mind-boggling scale of what will be one of the costliest bailouts in U.S. history.

The list of shockers is already long: Lehman Brothers failed over a weekend; the U.S. government assumed control of Fannie Mae and Freddie Mac and took on their combined gross liabilities of US$5.4 trillion; the U.S. government assumed control of AIG; U.S. Treasury Secretary Hank Paulson outlined a plan to spend US$700 billion through various channels to take on bad debt; the U.S. government is now insuring the holdings of any publicly offered, eligible money market mutual fund; Merrill Lynch sold itself to Bank of America, mimicking Bear Stearns earlier this year; there have been a string of gut-wrenching, single-day rallies and crashes in the global markets; Goldman Sachs and Morgan Stanley changed their status to bank holding companies from investment banks; and short selling was temporarily banned for U.S. financial stocks.

What it all means is that U.S. taxpayers will wind up assuming a huge burden for the soured mortgages in their country. And with so many prior “final” bailouts and so much bad paper out there, there’s little reason to believe this US$700 billion is the end of it, and people speak casually of the bailout swelling beyond US$1 trillion.

What’s one trillion dollars? It would add 18.5% to the federal government’s US$5.4-trillion debt. It’s almost twice what’s been spent by the U.S. on the Iraq War so far. It’s US$3,281 for every U.S. citizen or US$7,200 for every U.S. taxpayer. And it may result in a whopping US$1-trillion federal budget deficit next year.

But no one really knows how much it’s going to cost to get all the bad paper off the banks’ books. At the moment, some 5 million U.S. homeowners are delinquent on their mortgage or in foreclosure, and this could rise if the economy slows down.

Until we know these costs, we can expect more market volatility and enhanced risk aversion from investors, and that’s bad news for speculative mining stocks.

The definitive end of the U.S. housing boom will also ripple through the world’s economies, ratcheting down raw-materials consumption and prices.

On the other hand, gold’s monetary character has taken on a new luster. Give gold bugs their due: it’s taken many years to come to fruition, but they were right about all this toxic derivatives sludge in the U.S. financial system.

The only thing missing from the classic gold-bug scenario is that we haven’t seen a more spectacular rise in gold prices, but this should come in time as dollar inflation is chosen as the politically easiest way out of the mess. And that’s good news for gold explorers, miners and investors.

A distressing feature of the subprime mortgage crisis is the reflexive condemnation of capitalism by the usual lefties, and the broader calls for more regulation of the U.S. banking sector.

This is the exact opposite of what’s truly needed: far less regulation of private sector lenders and the unequivocal abandonment in the U.S. of the big-government, social engineering that perverted federal housing policy and created this subprime mortgage mess in the first place.

It all started off — as it so often does — with good intentions coupled with frighteningly bad policy: the Community Reinvestment Act, brought to life under the Carter Administration and the Democratic Congress in 1977.

The act was intended to stop so-called “redlining” by mandating that private U.S. banks extend mortgage lending into poor areas. The goal was to clear out America’s slums and create more homeowners, with all the dignity and self-respect that brings — laudable, indeed, and the program certainly had tangible successes.

Flash forward to the mid-1990s, and Fannie Mae and Freddie Mac were heavily politicized, Democratic Party-friendly behemoths and the Clinton Administration was strong-arming banks to lower their lending standards even further, playing the race card and provoking class envy as a cynical tool to shore up the party’s base.

By the new millennium, Fannie and Freddie were deeply corrupted at the management level, Alan Greenspan’s Federal Reserve was keeping interest rates at insanely low levels to stoke a housing boom, and Democrats in Congress blocked all Republican attempts to reform the subprime mortgage industry.

Last week’s blowout was 30 years in the making and it’s going to take lots of time, money, politicking and dollar inflation to undo the damage and recover.

The fact that Barack Obama’s presidential poll numbers are on the upswing because if this Democrat-induced crisis is a bad joke.

But again, it’s all good for gold, and the terrific news for our readers is there’s still time to climb aboard before the yellow metal’s next big moves up.