Government Bail out fails – That's a good thing
By glblguy
Yesterday was most likely one of those days that will go down in economic history. US lawmakers rejected the proposed Government bail out yesterday. As a result, the Dow suffered the biggest single day point drop in history. The Dow Jones industrial average lost 777.68, surpassing the 684.81 loss on Sept. 17, 2001, which was the first trading day after September 11th.
Why the panic? Fear that Congress might not be able to come up with a fix to the nearly frozen credit markets. Frozen markets mean that banks hoard cash which makes it difficult for businesses and individuals to get loans. While an inconvenience to individuals for businesses this can mean not being able to continue day-to-day operations. Businesses of all types depend on these loans and lines of credit to keep their businesses running and to make payroll while waiting for incoming payments.
What does all of this mean?
Well, I no even close to being a financial expert, so to answer this one I’ll defer to the experts which at this point are divided. Some are shouting complete economic failure, others say the economy will hold it’s own for now. The economists predicting failure base their prediction on a downward cyclical spiral. Banks hoard cash and make it difficult for businesses to get loans, this causes some companies highly reliant on credit to not be able to operate or make payroll. This results in job loss and people not being able to pay their bills. Those bills are what allows companies to pay of their existing credit. See the pattern?
Others though are a little more positive. They say credit lines for the most part are already out there and banks can’t genreally just pull them away. They argue businesses can survive a credit squeeze as long as consumer spending remains positive – which it has.
The Government bail out package
The Government bail out package is basically a piece of legislation designed to prevent a potential economic meltdown of the US Economy. The bills intent was to get banks lending again. How? By letting the US Government buy up the banks troubled debt caused primarily by the crash of the US Housing market. When I read this, I’m reminded of something I hear Dave Ramsey say. Dave often slams people for taking out home equity lines to payoff their credit card debt, especially when they say “paid off”. He quickly corrects them saying “You didn’t pay it off, you just moved it”.
Allowing the US Government to buy our banks troubled debt just moves the debt, it doesn’t get rid of it. But I am getting ahead of myself. The bail out package as proposed to the house on Monday provided the following key provisions:
Staged distribution: The $700 billion would be disbursed in stages, with $250 billion made available immediately for the Treasury’s use.
Repayment from banks: If for some reason the Government ends up with a net loss, the bill says the president must propose legislation to recoup money from the financial industry if the rescue plan results in net losses to taxpayers five years after the plan is enacted.
Treasury ownership in companies: The Treasury would be allowed to take ownership stakes in participating companies.
Stemming foreclosures: The bill calls for the government, as an owner of a large number of mortgage securities, to exert influence on loan servicers to modify more troubled loans.
Limiting executive pay: Limitations would be placed on the compensation of executives at companies that sell mortgage assets to the Treasury. Among them, companies that participate will not be able to deduct the salary they pay to executives above $500,000. They also will not be allowed to write new contracts that allow for “golden parachutes” for their top 5 executives if they are fired or the company goes belly up. But the executives’ current contracts, which may include golden parachutes, would still stand.
Overseeing the program: The bill would establish two government oversight boards. A congressional oversight panel would be charged with reviewing the state of financial markets, the regulatory system and the Treasury’s use of its authority under the rescue plan.
Insuring against losses: The Treasury must establish an insurance program – with risk-based premiums paid by the industry – to guarantee companies’ troubled assets, including mortgage-backed securities, purchased before March 14, 2008.
Bail out fail and I’m glad
I am sure I’ll get many people disagreeing with me, but I’m glad the bill failed. I don’t want the government bailing the market out. Our Government can’t even manage their own finances let alone those of the whole economy. By moving bad loans from the private industry into the government, they don’t go away and somebody will still have to pay for them. Who? Us and our children. Those bad loans will come out of our taxes, our children’s taxes, social security and a number of other different areas.
I certainly don’t want to scream socialism, but if it quakes like a duck…Our Government over the past few years has moving ever so slowly down the path of socialism. Talks of government health care, more government programs to provide for the needy, and how a complete bail out of an economic situation that frankly we as the American people got ourselves into it.
Note also in the bill I detailed above, that the line that says the Treasury can take ownership of companies. What? Now we potentially have legislation that allows our government to take ownership of privately held companies. I don’t know about you, but that scares me to death.
My vote is to allow the economy to play itself out with no government intervention. Sure, it might get a whole lot worse before it gets better, but in my opinion that is a far better option that giving our government even more control. The Citigroup purchase of Wachovia is a perfectly good example of a non-government solution. Wachovia saw a problem, and took steps to rectify it.
Thaddeus McCotter, R-Mich., said it best when he said the bill posed a choice between the loss of prosperity in the short term or economic freedom in the long term. He said once the federal government enters the financial marketplace, it will not leave. “The choice is stark,” he said. I agree.
What are your thoughts? Add a comment!
September 30th, 2008 at 7:13 am
I respectfully disagree with you. The longer it takes to pass the “bailout” bill, the closer our economy comes to the brink of disaster. Recessions are part of the normal business cycle; they clear out the deadwood. Depressions are destructive; they clear out deadwood and live wood, if you know what I mean.
Your point about consumer spending keeping the economy afloat is interesting (you say it has). Wait til the other shoe drops: How much will you be spending if you lose your primary source of income? Sure, “it won’t happen to me,” you might say. That’s what 25 percent of the workforce thought in the ’30s.
Yes, IT’S THAT DIRE.
Congress’ failure to pass the bill is due to politics. If there were ANY leadership in Washington DC, they would have passed this bill within one day of its introduction.
This is not a “bailout.” Unless, that is, you refer to bailing out the economy. It’s certainly not a bailout of Wall Street firms.
Our economy is like a river: It depends on the free flow of money. Why do you think the Fed injected over $600 BILLION yesterday?
The river is all but dried up. If you don’t believe me, try to get a personal loan today. Or, better yet, go try to buy a house. People with 800+ FICO scores can’t get credit right now! Need more proof?
Look at the money market. Money market mutual funds, for example, have always had an easy time keeping share prices pegged to $1. Several lately have failed that safety test, falling below $1. This is almost unheard-of. Only one time in the last 30 years had this happened until last week. When very short-term paper loses principal, it’s a dire warning.
So I think you’re dead wrong about this. You admit you’re not a financial expert, and it shows in your analysis and conclusion. I HOPE I’m wrong. Because we’re on the verge of an international calamity if we don’t inject confidence in this market. The Paulson Plan would have done that and more.
Count on the market seizing up today. Thanks to thoughtless people like you.
September 30th, 2008 at 7:20 am
I can’t disagree with you – the problem is that not unlike most macro economic scenarios – nobody (including herks like the first commenter) truly knows what to do and what the ramifications of inaction are. Is it really the end of the world if the bailout (or something similar) doesn’t happen? Maybe yes, maybe no.
One thing I know for sure – things will work out in the end….
September 30th, 2008 at 7:53 am
I at least like taking a bit more time to come up with a solution. This was years in the making and a week or two of planning doesn’t look good.
September 30th, 2008 at 10:42 am
Your analysis mimics that of most voters who this week indundated the inboxes of Congress. If you think the rescue bill was socialism in disguise, just wait for what happens when a Democrat President and Congress get together on jobless benefits, job creation, and other rescue packages for all those who will become unemployed if the bill is not passed. You will pay for it (if you keep your job) with massive tax increases and/or inflation. As for as socialism goes, the AIG bailout is a better example, as are the loan packages for the car companies which quietly passed Congress last week as well.
September 30th, 2008 at 11:23 am
I don’t think people fully understand the impact of this credit crisis, while it’s not a perfect solution, it’s something that’s needed to calm the markets so that credit can still be extended. One telling statistic is the amount of commercial paper available, which are short term loans that businesses need to conduct business, and it’s gone down significantly. I’m hardly an expert on this but we can’t continue to do nothing, the tightening will continue and we will face a severe economic slowdown/recession/whatever.
September 30th, 2008 at 11:31 am
No matter how you slice it, now much someone cries that the sun won’t come up tomorrow, this bail out / intervention / meddling was a bad idea. The deal, as it was structured, allowed the Treasury secretary to spend the money as he saw fit, buying up mortgage paper for the amount HE chose. The man’s a trader and he was jazzed by that amount of power in my opinion. How would YOU like the ability to play the market like THAT?
In a true free market, the losers pay and pay dearly. We don’t have anything close to a free market anymore.
September 30th, 2008 at 11:45 am
Ron – I am less concerned about the market and more concerned now about having business clients who can afford to hire me and pay my bills so I don’t have to lay off employees. I think Paulson is also worried about that.
September 30th, 2008 at 12:00 pm
I agree with Laura. I think we need just a bit more time to make sure we’re doing the right thing with such a huge sum of money.
I don’t even try to pretend I understand what’s going on (though I am trying) but for now I’m not feeling too stressed. Certainly that could change, though.
September 30th, 2008 at 5:44 pm
I’m surprised there aren’t more comments. I think the average American doesn’t know what to think. I know that when I tried to get a home loan in the late eighties, I couldn’t get one. I didn’t like it, but I trusted that the lenders knew what they were doing. I trusted them again in 2003 when I did get a home loan and again in 2005 when I did a re-fi. Now, I know that I was wrong to do so. I feel cynical and betrayed. All “markets” are constructs that I guess we have to “buy” into, but I wish I understood it a little better.
October 1st, 2008 at 11:03 am
We did a “Happy Dance” in our house. I understand there is economic instability and the bailout is meant to restore confidence. my suggestion? Remove capital gains tax and let those with money go shopping for stocks at bargain basement prices. Allow the market to fix itself. I realize that to remove the income generated by capital gains takes money out of the system; however, it promotes less additional debt than $700 billion.
October 2nd, 2008 at 3:27 pm
Congratulations to you taxpayers who who were adamantly opposed to the $ 700 billion bailout. The House of Reps voted against it. Immediately the stock market plunged to its biggest point loss in history (777 points on the DOW). International markets are plunging around the world. The U.S stock market has lost $1.4 TRILLION in value, thats 2X the $ 700 billion plan. If we had completed the $ 700 billion bailout, most or all of it would have been recovered and there may have even been a taxpayer profit made of up to $ 2 Trillion.
Everyone is way over-exaggerating the bailout at $700 Billion. What people don’t understand is that this money is not being spent – it is being invested in assets (loans) at fire-sale prices. These loans will be restructured and re-sold over time and taxpayers will make a profit.
We are collectively $ 1.4 Trillion poorer today. This number may increase if panic ensues. Be prepared to watch your Pension Plan fold up and not pay any benefits, your IRAs and 401Ks go to half of what they were. Be prepared for many of your insurance providers to fold up and not pay you a dime. Be prepared for your employer to stop giving you a paycheck because they can’t get the short term loans and cash they need to make payroll or manufacture products to sell.
The taxpayers have just shot each other in the foot. Why – because of a complete misunderstanding of how our economy works and because the media has fueled the fire of populist emotion without clearly explaining the logical conclusion of these bailouts – which are not nearly that bad. Lets just hope its not a fatal wound. see my blog on this at http://investingandeconomics.blogspot.com/