Bailout?

I’m seeing a lot of stuff coming out of the progressive blogosphere on the nature of and need for this $700 billion bailout of Wall Street that’s seriously troubling to me. I understand the skepticism in any proposal of this magnitude that comes out of the Bush administration. At the same time, Ben Bernanke is not some hack. Neither are the many economists who are, understandably, very concerned about the financial system and generally in support of some kind of comprehensive solution. This is serious business.

A lot of people are linking to this piece of commentary, which reads in part:

Ask this question — are the credit markets really about to seize up?

If they are then lots of business owners should be eager to tell how their bank is calling their 90-day revolving loans, rejecting new loans and demanding more cash on deposit. I called businessmen I know yesterday and not one of them reported such problems. Indeed, Citibank offered yesterday to lend me tens of thousands of dollars on my signature at 2.99 percent, well below the nearly 5 percent inflation rate. That offer came after I said no last week to a 4.99 percent loan.

If the problem is toxic mortgages then how come they are still being offered all over the Internet? On the main page AOL generates for me there is an ad for a 1.9% loan (which means you pay that interest rate and the rest of the interest is added to your balance due.) Why oh why or why would taxpayers be bailing out banks that are continuing to sell these toxic loans?

This is foolishness. For one thing, it is quite a bit more difficult to get a loan these days. As someone who has excellent credit, and who has recently applied for both a mortgage and a car loan, I can tell you that the difference between lending conditions now and in 2005 is dramatic.

But what about things like credit cards and revolving business loans? Look, if we get to the point where banks are restricting basic credit lines on which nearly all Americans depend for use in daily life, then we’re beyond recession territory–we’re in depression territory. And it’s not like things weren’t heading in that direction. Last week we were all sitting there watching the crisis progress from one institution to the next. Now that the blaze on the bottom floor is under control, people are like, “but we don’t know that it would have spread to the top floor!” And it’s not as if the threat has entirely diminished. Days after the bailout was announced, the spread between interbank lending rates and rates on loans from the government is some five times higher than it would be under normal circumstances. That’s huge. And it rose on Monday and Tuesday after falling over the weekend.

That’s one reason why time is of the essence. Confidence that a comprehensive solution is forthcoming has calmed markets for the moment, but if markets begin to doubt that a firewall against collapse is going to be there, then the downward spiral will begin again. Another reason is that jammed credit markets aren’t exactly healthy for the economy. Does this need to be done this week? No, but can it wait until January? Almost certainly not.

But what about the amount? How do we know that $700 billion is needed and not, say, $500 billion or $300 billion? Well, we don’t. But if that amount is off, then the correct amount is almost certainly higher. Read this to see the scope of the problem and the challenges involved. If Paulson didn’t request more, it’s probably because he thought this is the least he could get that would make a difference.

Get the oversight in there, please. Get a bipartisan team of experts involved. Get measures in there to ensure that taxpayers get a healthy share of whatever upside there is to the deal. Make the bill a good bill. But let’s not play around here. Healthy skepticism is healthy. Blind assessments of the situation as not dire, simply because you can still use your credit card are not.

Also: Let me say one other thing. We don’t really want to mess around under the assumption that foreign central banks will continue to act as they have. Foreign lenders have basically kept the economy going this year. Private capital inflows have basically stopped, however, and may be negative. If foreign central banks give up on us, that’s it.

Comments

  1. Greg says:

    It is possible, as you say, that not spending $700B could lead to a severe recession or a depression. And, as you say, it is possible that spending $700B might not be enough to keep us out of a severe recession or a depression.

    Given that, shouldn’t we consider whether there are other uses of that $700B that might be better? For example, $700B could provide a lot of fiscal stimulus.

    If used entirely for infrastructure spending, for example, it could provide 7M jobs at $50k/year for two years while rebuilding our rotten infrastructure and investing in the future of America’s economy.

    To put 7M jobs in in perspective, the number of unemployed persons in the US in August 2008 was 9.4M according to bls.gov, so the unemployment rate would drop from 6.1% to 1.6% with this kind of jobs package, clearly significant protection for the lower and middle class from a recession.

    The general question here is, given the uncertainty around whether spending $700B on bailing out Wall Street would fix the problem, is that really the best use of $700B?

  2. dieselm says:

    Warren Buffett invested $5B into Goldman Sachs today.

    For his cash, he received perpetuity preferred shares w/10% dividend, plus $5B more in options priced at 8% below the close.

    Can anyone here explain why if a bank like Goldman is stable enough for the world’s pickiest investor to put money in today, why we need to give $700 billion of taxpayer money for free, no strings, no dividends, no equity, no options?

    If Warren would up his investment to $7B, 99 more private investors like him and we’d be at $700 billion. Or we can give half of 2007′s personal income tax from every taxpayer in america to the banks for free.

    Outrageous. This crisis is a sham.

  3. moron says:

    Let the banks fail.

    The global economic, social and technological conditions are sufficiently different from those of the 1930′s that the outcome is unlikely to be so dire as people imagine.

    It would have been better to arrange a bailout in which the interests of taxpayers were protected.

    But it has become clear over the last few days that the banks would rather go on strike and let the system collapse than modify their fundamentally predatory relationship with the US public.

    Well, all right then.

    If they’re telling us with one breath that the crisis is so dire that it needs to be dealt with IMMEDIATELY, and in the second breath that it’s unacceptable for them to give up their golden parachutes or renegotiate mortgage terms with homeowners as a condition of expropriating the citizenry for 700 billion, then these are people who cannot, and should not, be acoomodated.

    Either let them fail, or else nationalize the banks, and make the stockholders eat a total loss.

  4. wag says:

    Let the banks fail! Any money spent should be spent on helping real working Americans and real businesses – not banks that are insolvent.

    Do what was done in the 30s – weeklong bank holiday, shut down the failed banks and reopen the solvent ones. Cover FDIC limits or even 2X the limits. Give bridge loans to real businesses that need them to continue in operation.

    What Bernanke and Paulson want is an UNLIMITED amount of money to hand over to equity holders, bond holders, and executives of failed banks. Its a travesty that they get even one DIME of our money – they’ve already gotten a ton of loans from the Fed.

    The Fed, and former Goldman chairman Paulson, created this problem. Giving them more power is NOT solving the problem. The consumer and corporate sectors got overleveraged. More cheap credit is just like giving a crack addict more crack. The solution is to wind down the sccam businesses that are building condos nobody wants, strip malls, and the like.

    Peter Schiff has it right. We must reinvest in productive capacity and local production. The moneychangers will lead us off a cliff with this insane proposal.

  5. kreiz says:

    Excellent post, ryan. You recapture the sense of urgency that’s being overlooked by partisanship and mistrust. Now’s the time for pragmatism. Make it work- now.

  6. monkeyrotica says:

    As someone who has excellent credit, and who has recently applied for both a mortgage and a car loan, I can tell you that the difference between lending conditions now and in 2005 is dramatic.

    Well, to be fair, they were handing out mortages to anyone with a pulse in 2005. And not giving everyone access to cheap car loans is a BAD idea? I thought FEWER CARS=GOOD THING?

    So lessee: we’ve got a trillion dollar defecit, a trillion dollar war debt (which POTUS doesn’t consider part of the overall defecit, and a $700 billion bailout that will probably end up over a trillion (if Federal spending is any indication). Seems to me that $700 billion should be spent on something more tangible like, say, INFRASTRUCTURE, MASS TRANSIT. Or ANYTHING besides rewarding stupidity. All this bailout will do is encourage more people to use their house as an ATM machine.

    Now, I’m no pinko com-simp, but I think it’s about time we flipped the current laissez faire paradigm on its head: instead of privatizing profit and socializing loss, it should be the other way around.

    Fight Club had it right: Advertising has us chasing cars and clothes, working jobs we hate so we can spend money we don’t have to buy shit we don’t need. Game over. Buy it with cash or don’t buy it at all. It just takes a little more TIME, but try telling that to Homer. “This thing can flash fry a buffalo in 40 seconds.”

    “AW, BUT I WANT IT NOW!”

  7. Zas says:

    There is clearly a lack of seriousness coming from some opponents of the bailout, but there are two powerful elements of unreality that cast doubt on the entire plan itself:

    1. The profoundly arrogant element of the initial draft legislation that prohibits any review by another agency or the judiciary. Now, one could claim this was designed to be thrown away during negotiations, but it’s indicative of the contempt in which the Bush II administration holds the Constitution that this verbiage would even see daylight. We just don’t want Paulson to be the Queen of Everything, thank you.

    2. The risible notion that financial services executives will reject financial support from the Feds if their compensation scam… er… structure is threatened. This leads to one of two conclusions: either the crisis is insufficiently severe to warrant any compromise from the banking industry, OR financial services executives are so psychotically attached to their self-interest that they cannot separate it from the good of the country and their institutions.

    I have found little to like about Sen. Obama’s experience or philosophy, but his Four Conditions for the bailout are spot on, pragmatic, and serious.

  8. Jon H says:

    “At the same time, Ben Bernanke is not some hack”

    Colin Powell had a good reptuation at one point, but he still gave his bullshit spiel to the UN.

  9. monkeyrotica says:

    So this is pretty much the financial equivalent of the Reichstag fire. That turned out really well.

    Mesa mosto Supreme Chancellor… Mesa gusto pallos. Mesa proud to proposing the motion to give yousa Honor emergency powers.

  10. Jon H says:

    “Now’s the time for pragmatism. Make it work- now.”

    Tell that to the financial wizards on Wall Street. Or is welfare their only hope? I thought they were free-market geniuses who could wring a profit out of a turnip?

    IMHO Wall Street is just pushing it now because they want to make sure they get their bonuses. That’s the only “urgency”.

  11. Reid says:

    “Wall Street is just pushing it now because they want to make sure they get their bonuses. That’s the only “urgency”.”

    This is a good example of an unserious critique of the bailout plan. I don’t think you realize how much the U.S. financial system collapsed last week.

    For instance, a lot of money markets had big exposures to troubled companies like Lehman and AIG. When a few of them ran into problems keeping their share price at $1, it caused a run on the money markets because they’re not covered by FDIC. But that meant that the money markets didn’t have cash to buy the short term debt (known as commercial paper) that is issued by bricks and mortar companies like Intel to actually run their business. To actually sell their commerical paper, the companies had to pay higher rates.

    When companies like Intel are having to pay 6% for commercial paper, that’s a huge problem. It means their cost of doing business skyrockets. It means people start getting layed off.

    But when the government floated the idea of insuring money markets, the banks responded by pointing out that there’d be run on the banks as people would move their money over to money markets (since they pay higher rates). This would’ve been yet another catostrophic event. (the government backed off that plan).

    Basically the entire back-room credit market that is the grease that keeps the economy from siezing up ran dry. We were essentially trying to run a bone dry engine. You don’t have to watch too many Penzoil commercials to know what happens next.

    Trying to make this into some simple Wall Street fat cat story is just wrong.

    How Wall Street works, how the government supervises it, and how people get paid will all change dramatically soon, but in the meantime, we need to pour some grease into the engine before it blows up entirely.

  12. Matt D says:

    The fact that its harder to get loans than it was in 2005 is not an indication the bailout is necessary. In fact, that’s the whole point: Debt was too easy in 2005.

    If debt is more costly, that’ll slow the econonmy for a bit but will probably be healthy in the long run.

  13. Dan Staley says:

    Ryan, you seem to have missed the important fact that the bailout is proposed by BushCo.

    And it is being rammed down throats like every other FUBARed thing they have done to enrich their benefactors.

    This alone is enough to reject the proposal.

    Please. Take a breath. And watch Kevin Phillips on Moyers last week.

  14. jim says:

    LIBOR under 4% is not a credit crunch. I am old enough to remember days when overnight money was at 9%. We didn’t think we were in a credit crunch then. Why do we panic now?

    Let’s not argue on anecdotes. If you want, I’ll match yours with mine. My eldest daughter had to replace her car which got totalled. She had a choice of loan: 4.5% from her credit union on the entire price or 4.74% from Toyota on the entire price. Money is available.

    It isn’t available as freely as it has been in the past, but that’s a feature, not a bug.

  15. BruceMcF says:

    Not even Paulson argues that he will spend a big chunk of the $700b by Halloween.

    So do a short term package, an immediate appropriation of $150b, designed so that the Bush administration cannot sidestep oversight and control provisions.

    For example, $75b for the purchase of toxic waste assets, and $75b for the purchase of newly issues first class preferred shares. Preferred dividend of 8% on the face value. All purchases of toxic waste have to be matched dollar for dollar with a issue and purchase of the preferred shares.

    Under the terms of the preferred shares, unless and until the dividend can be paid in full, executive compensation is capped at $10m for the twenty highest paid executives, executive termination compensation in excess of two weeks salary is deferred, no stock option compensation is allowed at all that matures in under five years, and of course no common stock dividend may be paid.

    When the Public Trust resolves the bad debt, hold onto the Preferred shares, and issues a Social Dividend to each citizen each year.

    And adjourn Congress until after the election.

    After the election, Congress can decide what to do with regards to the balance of the bail out, in cooperation with the administration and the President-elect.

  16. Bunker says:

    Does this need to be done this week? No, but can it wait until January? Almost certainly not.

    But what about the amount? How do we know that $700 billion is needed and not, say, $500 billion or $300 billion? Well, we don’t.

    “Almost certainly” is self-contradictory.

    It seems to me, we could avoid the panic which leads to bad decisions, by starting with smaller tranches and seeing what’s needed as we go. That would give time to consider ALL OF THE ALTERNATIVES, and put together something that benefits everyone. As it is, Paulson and Bernanke seem to feel like this is a borrower’s market, so the are crafting a bill that will ATTRACT participants. This seems exactly backwards to me.

  17. Dan Staley says:

    As it is, Paulson and Bernanke seem to feel like this is a borrower’s market, so the are crafting a bill that will ATTRACT participants. This seems exactly backwards to me.

    They are the appointees of who, again? What other supposedly trustworthy father figure did BushCo’s bidding?

    Wake up, folks.

  18. Chris says:

    Yes, it’s serious business. And sorry, but what is reckless is to assume *any* good faith on the part of Bush administration officials. Have we learned nothing from the last seven years? (And are you familiar with Naomi Klein’s Shock Doctrine?)

    Before you dismiss this as another progressive’s conspiracy theory, ask yourself:

    Why did Paulson tell Congress repeatedly that he welcomes oversight, when the plan explicitly rules out oversight?

    What are we to make of reports that this proposal was actually drafted months ago?

  19. PghMike says:

    Here’s a quick question — why do we have to bail out *all* of the owners of bad securities?

    Why not offer to buy securities for equity, for a limited number of commercial banks. The announced criteria would be that the Treasury will look at the books of the banks, and make the bail out offer to the best 1/3rd of the banks.

    What do I mean by best? Something like the banks with the lowest percentage of bad securities compared to their market cap.

    With this approach, you get to preserve a decent amount of the commercial banking sector, while reducing moral hazard (since imprudent banks get none of the bail out). The banks requiring the bail out will require the smallest bail out, so the bail out cost is reduced significantly. The surviving banks can grow to absorb the business of the failing banks, especially if the Fed maintains liquidity throughout this process.

    PS: I like Bruce McF’s proposal — do a small fix now, with significant strings attached, if things really are that critical.

  20. BruceMcF says:

    Note that this is simply wrong:

    Look, if we get to the point where banks are restricting basic credit lines on which nearly all Americans depend for use in daily life, then we’re beyond recession territory–we’re in depression territory.

    It means we are in severe recession territory. We are in Depression territory if the damage done in the onset of the recession is so severe and difficult to fix that the recession hangs on for multiple years.

    The steepest drop in GDP in the 20th century was not 1929, but 1946. But because the post-WWII recession was so short, so many people had savings to tide them over from the forced savings during WWII, and the recession was short enough, that it did not kill economic growth in 47 and 48.

    And regarding this:

    Does this need to be done this week? No, but can it wait until January? Almost certainly not.

    … is a red herring. Its not what has to be done in 2008 and what can wait until January … it’s what has to be done in the next six weeks and what can wait until mid-November, after the election.

  21. ryan says:

    Bruce, “severe recession” is the definition of depression.

  22. BobN says:

    “we need to pour some grease into the engine before it blows up entirely” The bailout seems to be asking us to pour grease into the luxuriously appointed interior in the hopes that it makes its way into the engine. If the problem is liquidity, why can’t the bailout go directly into sustaining the lending system?

  23. RustyJohn says:

    Here is an idea- let the bad debt work its way out of the system by letting institutions fail. In 6-12 months we will be working our way out of this mess and the dollar won’t be pissed down the toilet.

    It is not a recession or a depression. It is a CORRECTION from years of bad actions by government, individuals and corporations. Let it happen.

  24. Pheeva says:

    I am a financial political laymen but It is obvious to me you all either have a better handle on this than our executive and legislative braches or there is some real misdirection going on at “BushCo.” So I beg the question. It is not coincidence this comes to a head 1.5 months before Bush is done for good? This seems to be his last chance to siphon more money out of our economy. Give $700.B to my buddy that he can hand out with no oversite as he wishes. We knew this was coming for some time (“Irrational Exuberance”). It seems to have been saved for an opportune time. Why the $600. to all tax payers instead of dealing with the underlying problems then? Seemed like a calculated forbearance of this issue until the election time where all who are up for re-election will have difficulties being vocal and stepping out to the forefront of an issue no one (in federal government) sees to know the solution to. All of the most divisive and expensive decisions have been made by the Bush administration in this same way.

    1. Climate of fear generated and perpetuated by the adminitration seemingly complicit with the mainstream media.
    2. Haste – Something needs to be done right NOW before anyone can look it over fully.
    3. Calls for increased power to the executive brach or his trusted buddies.
    4. Anyone who is against it is unpatriotic or in this situation blocking progress of relief to the “Main street American citizen.”

    Am I off here? Remember I am a layman please educate me…

  25. BruceMcF says:

    Its not coincidence. What they were trying to do was to kick the can down the road so the next administration could worry about it. But September/October are often tight months in the ebb and flow of the annual credit cycle, and it turned out that a year was all that they could succeed delaying the problem.

    So now Paulson wants enough money with enough control over that money so he can clean up the mess he and Bernanke have made of the Federal Reserve balance sheet, and also a bit of recapitalization and hope to stave off the melt-down until after Christmas, maybe even until after the Inauguration.

  26. Mr. Avent,

    I think you misunderstood the purpose of my post. Your selection of its minor points rather than its overarching ones has created among your fans a misleading impression.

    I was not asking questions to solicit answers for myself. I know the answers.

    Indeed, I was one of those who years ago saw a collapse of artificially inflated asset values coming. I wrote about it in articles in The New York Times, in my book Perfectly Legal (written five years ago) and in hundreds of lectures) and in my current best-seller, Free Lunch.

    My post were at two websites for journalists. These posts were a call for journalists to remember the first rule of journalism — check it out.

    The initial coverage of this issue at the end of last week and over the weekend was naive and gullible. There was little checking and even less cross-checking.

    Just because someone, even the President or Treasury, says something does not make it so.

    More importantly, by assuming that what was said was just so, journalists were not explaining the context of the problem, which is a major reason that some members of Congress report calls are running 200-to-1 against ANY bailout.

    Good ideas stand up to scrutiny. Asking those questions helps inform the public, especially on subtle issues that are not widely understood.

    Most reporters are generalists. They do not understand corporate finance, especially not subtle and complex instruments of the kind which I am well-known for describing so that average Americans can understand them.

    The fact is that Joe Sixpack looks at the new letters in his mailbox offering credit and asks himself, “what credit crisis?” The questions you cited (and the details I cited) were intended ot provoke journalists to think about the average reader.

    For reporters working in Washington, in my view, too often reports are written more for the inside-the-Beltway crowd than the rest of America. (I covered Washington from New York City and Rochester and routinely broke stories without going there, stories that were written to inform all Americans.)

    Skepticism is basic to journalism. All I did was try to stir reporters to check it out and, hopefully, to also ask about alternative solutions. Is there a market solution? was one of those questions.