Letter from Sears Chairman

The comprehensive and expansionary Letter to Shareholders from the Chairman Edward S Lampert includes a warning against the current fervour for nationalisation;

"...I believe that the primary problem with the financial system has been a funding problem rather than a capital problem. What this means is that our banks went into this crisis with significant levels of capital and several have raised considerable levels of additional capital since. Nevertheless, their ability to fund their business on a day-to-day basis was compromised at times during 2008 due to dislocations in the capital markets. When Bear Stearns ran into funding problems in early 2008, the Federal Reserve and Treasury stepped in to arrange a merger with J.P. Morgan. Only a few days before this happened senior Bear Stearns officials were assuring nervous constituents that the bank had significant capital and liquidity and could weather the storm. However, when confidence in a financial institution is compromised, very few can survive without some form of assistance, especially when events unfold with such speed and are accompanied by rumors, speculation, and fear that only time can dispel.

...On September 7, 2008, in the largest nationalization in American history (executed expeditiously and without an obviously transparent process), the U.S. government announced that it was placing Fannie Mae and Freddie Mac into conservatorship. As part of the conservatorship, the government would provide capital support, if necessary, of up to $100 billion to each GSE through Preferred Stock Purchase Agreements. Although no cash changed hands, in consideration of this backstop, the U.S. government received 80% of the common stock plus $1 billion in preferred stock in each institution. This backstop has recently been increased to $200 billion as part of the Homeowner Affordability and Stability Plan. In the process, they suspended dividends on existing preferred stock of both Fannie Mae and Freddie Mac, eliminating approximately $36 billion in value, most of which was held by the major commercial banks in the United States.

Rather than help solve the housing and mortgage problem, the unintended consequences of this action were manifold. First, bank capital was depleted. Not only was $36 billion in GSE preferred wiped out, but the whole market for financial preferred securities went into a free fall, wiping out additional equity from financial institutions, including many large insurance companies. Second, despite the boards of directors of Fannie Mae and Freddie Mac consenting to conservatorship, neither company has ever given an explanation for its consent. For those who are sophisticated in finance, neither Fannie Mae nor Freddie Mac had a “funding” problem. Because each GSE’s balance sheet was comprised of highly liquid Mortgage Backed Securities (MBS) that pay off on a monthly basis, it should have been easy for either to pledge securities to raise money or to shrink their balance sheet and meet their financial obligations as they came due. The logical explanation for the boards of directors giving consent rests with the presumption that if they did not consent, there was some other threat that would have been even worse for those directors. As for the shareholders the directors represented, it is hard to imagine anything worse than having their investment effectively wiped out, and they had no vote on the matter.


..The two most important books that any student of current events should be reading in this environment are both by Friedrich Hayek, the esteemed Austrian economist. Based on events he witnessed beginning in the early part of the 20th century, Hayek wrote The Road to Serfdom as a warning to England and the United States against the damaging impact of socialist policies and The Fatal Conceit as a warning against heavy intervention in markets and society at large. Despite the almost universal belief today that more, but better, regulation is needed and that the role of the state needs to be not just temporarily larger, but permanently larger, Hayek’s writings and logic should give everybody pause as to the consequences of these actions.

As a country, we need to rebuild confidence and trust and to understand what happened. Whether by business or by government, the misdiagnosis of situations leads to poor prescriptions for rehabilitation and recovery. When the misdiagnosis is done at the federal government level and involves large parts of a national economy, the consequences can be swift and significant.

The unintended consequences are often swifter and even more significant. As the leaders in our nation continue to evaluate and evolve the policies and rules of the game, we would all be wise to heed the cautions raised by Friedrich Hayek. I appreciate that the free market can be a difficult master and that there is an important role for government and regulators, but I hope that as we move forward the rules of the game and the methodology for changing those rules will be more consistent and fair than they have been over the past year. Those who desire to protect civil liberties in times of war appreciate the importance of laws protecting individuals and institutions. In times of economic and financial distress we need to be similarly vigilant in protecting economic and contract rights so that we can continue to have a system that functions properly. Attempts to threaten or eliminate those rights will chase away the capital and investment that our country needs to restore prosperity and to thrive in the future..."