Global Negotiations & Silver Linings

As banks fail around the world (15 in the U.S. so far, but there will be more, and many more around the world), as Russia had to bail out the financial system of an entire nation (Iceland, which is still teetering), as leaders from the “G7 countries” (U.S., Japan, Germany, Britain, France, Italy and Canada) meet and pledge to take "decisive action and use all available tools” but are really short on specifics, and as those credit default swap (CDS) instruments hit the $62 trillion mark, where is the silver lining? There are many.

First, we are finally getting rid of all those “too good to be true” financial instruments and the idiots (fraud-meisters) who created them. Back to fundamentals.

Second, the huge number of CDS instruments (default insurance paper) are 1. going to be standardized and uniformly rated, and placed into a regulated clearing house, 2. they are mostly in the hands of financial institutions or super-rich people (OK there are a few mutual funds and pension plans in this mix, the bad part) and not common in individual “average” portfolios, 3. the institutions that created them and profited heavily are just that, institutions – not people – we can live without, and 4. if the market bottoms out and stabilizes, the CDS default rate will track the market.

Third, the investment markets now have to focus on true value growth companies as opposed to companies that like to generate “financial transactions” solely for the purpose of generating fees. When you think that in normal times, U.S. companies trade somewhere at 12-13 times earnings, if there are solid bets trading at less than that number and you can hold on to the stocks long enough… there are real bargains out there. Just expect a bumpy market for a while. And short term, companies that focus on the middle class – the group hit the hardest by this mess – are going to suffer more than those aimed at the top or bottom level consumers.

But there are fundamental differences from what foreign governments and financial institutions might want from what is best for America . After all, the triggering market anomaly for this meltdown was the accelerating default rate on subprime mortgages (which does not mean “borrowing at below the bank prime rates” – it means that the borrowers’ creditworthiness was well below the standards of fully qualified borrowers) based on American residential real estate. And this blossomed out into the world of overall U.S. real estate values and even to fully performing mortgages, again, primarily based on U.S. residential real estate. Not real estate or subprime borrowings outside the U.S.

The American economic upper class, except for the exceptionally greedy who deserve to tank in a payback for profiting from this overextended economy, are insulated from the big pain by raw wealth, even if the mass of richness may be diluted. The bottom of the economic ladder will suffer from even leaner times, but they have lower to fall. The middle class will absorb the brunt of the pain, and our own drastic focus, at least initially, has to be on restoring the values – jobs and home values – that are the basics of all but the lucky few at the top of the wealth curve.

Foreign companies were hurt as they took on stupid investments based on under-qualified borrowers and over valued American real estate. Foreign governments want their companies bailed out; it wasn’t their residential real estate market that caused the problem. While Americans have concerns for their financial institutions, our government should be focused first on bailing out individuals.

This interplay between emphasizing individual versus corporate solutions will be the test of our economic leaders’ mettle; and Paulson seems to be succumbing to global pressure to start with institutions. That continues to be a big mistake for us, and in the end, a big mistake even for the foreign governments who really need a sound platform upon which to rebuild credibility in the global economic structures.

I’m Peter Dekom, and I approve this message.