How John Lee Would Clean Up the Financial Mess and Put $800 billion to Work (Part I)

Nov 26, 2008 by John Lee, CFA (

The Fed and US Treasury announced today a further plan to buy up to $800 billion of mortgage backed securities. This is in addition to the $700 billion financial bail-out package announced in September. In just past 3 months, over $1.5 trillion has been committed to help home owners and solve financial crisis.

Let’s get this right: Countrywide (now Bank of America) lent Bob $1 million for a home that’s worth $200,000. The genius AIG comes in and insures this mortgage and collects a premium from Countrywide.

Now that Bob can’t make the credit card and house payment, troubled American Express gets a $20 billion help out, AIG gets a $150 billion bailout from the insurance obligation, and Countrywide gets to sell Bob’s non-paying mortgage to the Fed?

So what does Bob get from this rescue? Nothing.

Don’t be fooled by Mr. Paulson. The case above is not an over simplification; it is exactly what is happening.

If you were to ask a libertarian like Ron Paul about who the government should rescue, he will say, “No one”. In normal circumstance I would agree, however, we are living in unusual times. We had over 25 years of massive credit expansion so the current debt implosion, with no intervention, will cause a spiral of asset price deflation, social chaos, and leave several tens of millions of Americans on the street.

If Mr. Bush really wants to help, the government is much better off giving money directly to the homeowners in trouble. And it can be done: Of the total $10 trillion US residential mortgages, upwards of $3 trillion are non-performing. It will cost a mere $150 billion to pay the interests of those $3 trillion mortgages for one entire year at 5%. This will immediately alleviate foreclosures, and temporarily stop the bleeding in the values of mortgage securities. To those who faithfully make payments, they can deduct 200% of the interest payments from tax returns. This “tax cut” will likely cost another $200 billion. For the savers who are mortgage free, waiving capital gains tax will generate interests in investments. The plan will also have the pleasant side effect of generating housing demands by folks taking advantage of interest tax write off and zero capital gains tax. The total cost of such a proposal will still be well below that of Mr. Paulson.

I can’t find any rationale to bail out toxic mortgage investors. I am still waiting for a bailout from last night’s black jack losses.

What about the ailing banks? Banks are like airlines, however badly managed, they must exist for the economy to function. However, I would not rescue Citi, which benefits solely Citi’s shareholders such as the Saudi Prince and the Singaporean government. Instead the US government should only buy viable assets from Citi and other failing banks. These assets include buildings, machines, and banking networks. Next the government should institute a new federal bank with a clean slate to resume residential and commercial lending. The new bank would have oversight by independent audit firms and a reasonable salary scale. After the crisis subdues, the new bank can then seek IPO and replenish the US treasury with the proceeds.

The idea of nationalizing banks may sound anti capitalistic, but it is exactly what we are doing right now. In fact, we are doing worse as we leave the good assets to the bankers and bank shareholders and buy the worst toxic waste from them. This makes no sense at all.

While we are debating where the government should spend its bailout money, the funny thing is, the government doesn’t have the money! The 2008 federal deficit is over $500 billion, and if the bail out programs comes into effect, the federal deficit could easily top $1 trillion or even $2 trillion in 2009.

Where does the money come from you asked? Stay tuned for part II, where we discuss the current investment climate and how to protect and profit from this mess.

John Lee, CFA.
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John Lee, CFA is an accredited investor with over 2 decades of investing experience in metals and mining equities. Mr. Lee joined Prophecy Development Corp. ( in 2009 as the Company’s Chairman. Under John Lee’s leadership, Prophecy raised over $100 million through the Toronto Stock Exchange and acquired a portfolio of silver assets in Bolivia, coal assets in Mongolia, and a Titanium project in Canada. John Lee is a Rice University graduate with degrees in economics and engineering.