The Bailout Round II: Adult Version?
In spite of its best efforts, the Bush administration failed to push through a $700 billion give away to Wall Street. President Bush conjured up scary images of the Great Depression on national television. He even partially backed away from his initial demand for a complete blank check for Henry Paulson. But the public refused to send their tax dollars to Wall Street banks run by incompetent bankers, and they insisted that their representatives in Congress listen to their wishes.
While the editorialists are busy denouncing members of Congress for surrendering to the vulgar masses, it's a good time to quickly check the score card. The United States is in a recession and facing the worst financial crisis in almost 80 years because the folks currently in charge were out to lunch.
They allowed an $8 trillion housing bubble ($110,000 for every homeowner) to grow unchecked. People like Henry Paulson, Ben Bernanke, and Alan Greenspan repeatedly insisted that there was no housing bubble as house prices got ever further out of line with fundamentals. President Bush regularly boasted about record rates of homeownership as the sleazes at outfits like Countrywide, IndyMac, and New Century pushed predatory mortgages on moderate income families, many of whom were black or Hispanic.
It just took a little common sense to see that a disaster was imminent, even if the exact timing and course could not be predicted. But, our elites lacked commonsense, and that is why we now face such a dire economic situation.
The main cause of the economy's weakness is not insolvent banks and lack of credit; it's the loss of $4 trillion to $5 trillion in housing equity as a result of the bubble's partial deflation. Families used their equity to support their consumption in the years from 2002 to 2007, as the savings rate fell to almost zero.
With much of this equity now eliminated by the collapse of the bubble, many families can no longer sustain their levels of consumption. The main reason that banks won't lend to these families is that they no longer have home equity to serve as collateral. It wouldn't matter how much money the banks had, they are not going to make mortgage loans to people who have no equity.
And house prices are not going to come back. This is like Pets.com. We are not going to get the price of $200,000 homes in central California back up to $500,000.
The main problem in recovering from the recession will be finding ways to boost demand other than household consumption. In the longer run, this will mean reducing imports and increasing exports. In the short-run, we will have to rely on government stimulus to help spur growth and reduce unemployment. The Democratic demands for stimulus were not extraneous to the legitimate goal of a bank bailout bill. Fiscal stimulus must be central to any serious effort to boost the economy.
The weakness of the banks contributes to the downturn, but they are not the core of the problem. We would still be facing a recession even if all our banks were flush with cash. Hence the hype about the urgency of the bailout was an invention. It would be good to get our banks in order, but it also would be good to send $100 billion to state and local governments to support infrastructure projects and other spending.
How do we go about getting the banks in order? Almost every economist I know rejects the Paulson approach and argues instead for directly injecting capital into the banks. The taxpayers give them the money and then we own some, or all, of the bank. (That's what Warren Buffet did with Goldman Sachs.)
This isn't about begging for a sliver of equity as a concession for a $700 billion bailout, this is about constructing a bank rescue the way that business people would do it. We have an interest in a well-operating financial system. There is zero public interest in giving away taxpayer dollars to the Wall Street banks and their executives.
If Secretary Paulson constructed a package that was centered around buying direct equity stakes in the banks, he could quickly garner large majority support in both houses. Better yet, Congress could just construct its own package centered on buying equity stakes and send it to President Bush. If he balks, we can just threaten him with stories about the Great Depression.
Loading comments…
Want to reply to a comment? Hint: Click "Reply" at the bottom of the comment; after being approved your comment will appear directly underneath the comment you replied to
Dr. Baker correctly identifies the housing bubble as the primary killer in the current crisis. But he seems strangely insensitive to the ruinous consequences of the yield spread between short term government securities and longer term bank lending rates. This is a situation that is already beginning to paralyze commerce in both America and Europe. At present rates it simply isn't worth it for banks to lend money. How big a problem is that?
Banks have lent money to Deadbeats for too long !! The banks should just charge higher interest rates and lend to fewer people and businesses!!
Let all the businesses that need short term loans to survive fail !! let the ones that have plenty of cash on their balance sheets survive!!
Stop bailing out banks that recklessly lent money to deadbeats !!
Don't show your ignorance. Banks perform a rigorous examination of all homeowners documentation before preceding to substantiate a home loan, therefore, don't assume the homeowners are deadbeats. Banks saw an opportunity to sell ARMs and make more money in a shorter time span. If you finance an ARM for 27 months, within less than 3 years, you have a homeowner that has to refinance their loan due to interest rate fluctuations and the banks make MORE money on a new loan. It's that simple! In addition, the U.S. has experienced 605,000 jobs lost in 2008 thus far and I'm positive that the number of unemployed has significantly impacted the foreclosure market.
Washington buying equity states in financial institutions? Why not just nationalize the financial system? AIG is essentially owned by the government. Why stop there? Oil is an essential commodity, nationalize it. Transportation, railroads, airlines, trucking companies are necessary in time of war, nationalize them now before it’s too late. Since Washington knows best why not just nationalize everything, all money flows to the Feds and they can decide how much you need to live.
You're absolutely right, FOF. Don't take an equity stake in exchange for a huge investment. Don't apply business principles to business.
No, that road leads to socialism.
Instead, just give money away, no strings. GIve the market a little dead-cat bounce just enough for the stupid wealthy to pull out their savings (the smart ones are already long out) using the 700 B viagra.
Then, watch the economy continue circling the drain. With 700B less to invest in job creation, infrastructure, green growth, etc. And with no equity stake in those few institutions that may weather the storm.
Excellent.
For a “Free Market” to work business has to given the freedom to fail, otherwise you have a form of mercantilism. Bail them out, take them over, turn Socialist, and you really can watch the economy circle down the porcelain thunder mug.
Credit-worthiness of the US is roughly zero.
Therefore, recovery cannot come from the credit markets.
The correct fix is a massive public works program. Infrastructure projects that provide well-paying jobs for average Americans.
The financial sector must shrink and the cash sector must greatly expand.
Nationalise the banks, clean-up their balance sheets and then resell them.
Put cash in the pockets of average Americans.
I haven't read every comment here, but this article and all the comments I've read so far are FAR AND AWAY the BEST dialogue I've yet seen during this "crisis."
Personally, I want to see this "crisis" be the beginning of the end for the Federal Reserve as we know it today. It is a huge part of the problem. It's a PRIVATE consortium of large banks and is NOT responsible to the people. The Chairman of the Federal Reserve is chosen by the President, but that's about it - nothing else about it is connected to our democracy. There are no checks, no balances, etc. Read up about it; the Federal Reserve - as currently formulated - is an evil that our founding fathers said was a key reason why many wanted to part-ways with Europe, right up there with freedom of religion was the freedom to not be under the thumb of bankers! Do Your Research!
If we created a NEW Fed, wholely owned by we, the people, but with all the existing powers, etc, it would be a boon to our society. I recommend we create a new, publicly owned Fed, seed it with a couple of hundred B, and set it on its way... Maybe give it a new facet to the Fed's charter, to give a priority to helping fund infrastructure at state and local levels throughout the US...
.
.
Here is an alternative plan: Offer new loans to homeowners with rates that are government-subsidized, and therefore lower than their present rates. The terms would be longer. There would be a fee for participating which would be amortized into the new loan. The loans would be offered through existing lenders.
This way, distressed borrowers are able to make their payments and stay in their homes. Lenders start receiving income again from their previously unproductive loans. Liquidity is restored to the system.
First, the tax payer does not have the money to bail what so ever out. The $700 Billion would be additional US debt, for which the government has to sell treasuries. Since our overall value dropped by $5 Trillion, other countries and lenders might decide that there is no collateral to support that move. Has anyone seen statistics on how much of the mortgage debt is owned by foreign banks and institutions, Hong Kong Shanghai Bank Corporation (HSBC), or how much of the mortgage holder banks is owned by foreigners? I think we are really close to the point of too much debt too little collateral. This crises has also uncovered that we have to produce more in house, subsidies and incentives should remain for those producing entirely in the US. The package has to look more like an investment than a bail out. The current package is ridiculous.
Hoelder,
What if the FDIC that is charged with Receivership of failed banks and deposit insurance of those failed banks is looking at a black hole of responsibility that it cannot meet, either deposit insurance fund wise and personnel wise? Instead of closing banks they quietly and tactfully arrange for purchase and assumption. BAC takes Countrywide, Merrill takes WAMU, and JP takes Wachvia (if memory serves). But the only way the FDIC can arrange for the "take-over" for these failed institutions is if they, the FDIC, can make a commitment that the mbs that transfer will be purchased from the books at a predetermined market floor? Remember, the FDIC fund is a mere $60 bil. The $700 bil is part of the arithmetic in the assumption transactions that have taken place. It was for the skin of the FDIC. What prey tell do you think happens to the psychology of this country if the FDIC fails? I think this is what is going on. Or, at least some variation of this. The truth is not being told. It's trust me, "I know what I'm doing" which certainly pisses all over the notion of democracy.
Why not just create a People Credit Fund and loan money at 4% interest rate (Fed Interest Rate is 2%) to companies that can present a healthy balance sheet, reflecting real assets and not assumptive and fictive assets. Like this the serious one can go on doing business and meet their obligations, like payroll etc. (by the way 4% will help them become even stronger because it's the best loan they will ever get and we the people still make a 2% profit!). Let the speculators rot ! What do you think?
K.I.S.S--what could be simpler? I like it. Where are the brains of Congress? They want to spend our money...and give us nothing in return!
http://www.federalreserve.gov/releases/h41/Current/
This is a link to the balance sheet of the Fed. (Part 4,)
The problem with lendable funds is "liquidity". The Fed lends money to banks in a variety of ways and the Fed blood stream for the international transit of money make the Fed the clearing bank.
If a People Credit Fund could loan money at 4% to companies can you imagine where the supply of funds for this lending would come from? Banks create money by booking loans, the money is the oft referrred to "credit" which is a credit to a deposit (in the Fed system) account of the borrower. A Fund would not be able to "create" money in the banking sense and would need a source of funds. Those funds would have a cost and that would negate the benefit you see in this sort of solution.
Not only has the housing bubble collapsed, but with it the bloated construction industry and all the jobs it generated. If these are not replaced, there will be a depression.
Obama has a stimulus program much like the New Deal, the Reps have nothing, they're not even willing to put the banks (and the international business that goes with them) back together.
The New Deal gave birth to Fannie Mae.
Which worked great for 70 YEARS until the Republicans gutted the regulations that surrounded it and kept it honest!
Ronald Reagan was WRONG!
The problem is not GOVERNMENT. The problem is BAD GOVERNMENT!
When you elect people who see ALL government as bad, you get BAD GOVERNMENT.
Fannie Mae was a big success for 70 years, until Bush.
Was the fault with Fannie Mae, or with Bush?
Exactly. And people think all of the foreclosing is on families and throwing them out of their homes, but a lot of speculators bought two, three or more homes with the idea of flipping them quickly and making a killing. Builders also went crazy overbuilding.
I believe that the idea of the government injecting capital into the bank by buying shares has an excellent chance of working. It worked in Sweden. But I can just hear the howling in the Capital that this is "Socialism" and I guess it is. The Paulson plan is socialism also but only for the rich.
Anyone who proposes this plan would be painted unamerican I am afraid. I was hoping Obama would propose it but he would be handing McCain a club with which to bludgeon him. Perhaps if Obama gets elected...he will try implementing it then.
The ownership injection of cash by preferred shares with the Buffet preferred dividend is a wonderful sounding idea, but it does not get at the problem of excising the toxic cancer. As I understand it, these entities, these banks would jettison all their mbs, however, there is no market for these assets. If you were a bank and the government bought new capital of your bank injecting sumptous cash what would that do for you in getting rid of the toxic assets? (the answer is nothing) The stock injection would help with capital requirements, yes, but the cancer would still exist. Awhile back, the discount was terrible for this paper. Now there is no water in the pump to even touch it. This is the purpose of the $700 bil. Sandford & Son, the junkyard of credit that nobody else wanted. (Think of Paulson as Fred Sanford)
Stop blaming the people for this economic crisis. Why doesn't anyone admit the real cause of our economy crisis: the trillions of dollars of national debt caused by the Iraq war!!! President Bush has mortgaged our country to the hilt! He has squandered our resources. Our jobs have been shipped to other countries. Bad loans on Wall Street is but a tip of the iceberg. We need to address the root cause before we can begin find good solutions to our problems. Isn't it time to be open and honest about why we are in this place at this time?
Yeah, it's all Bush's fault. If your going to put the blame on someone, it may as well be a lame duck.
When you got your tax relief check, did you spend it, donate it to charity or send it back to Washington?
Absolutely, Bush paid for the war with funny money, which launched $ devaluation, which launched the credit bubble.
And the war goes on and on, even into Pakistan.
I despise the Bush Administration as much as anyone if for nothing else but my blinded vet son. HOWEVER, it is Bill Clinton who is responsible for NAFTA, which sent our country scrambling overseas.
I think we should stop blaming a failed economy and disgruntled House Speakers for this problem. We are the ones at fault here. Too many people live a life of debt. Being able to "Afford" something has come down to "Can I make the payments?" I hear people talk about "My Home" or "My Car." I have news for you, you DO NOT own that home or that car. The entity that loaned you the money owns it.
I hope congress does not bail out Wall Street and that this country goes into a depression. Only then will people that should not get loans, not get them. We do not need to get a new car every two or three years. We do not need to get a bigger house just because we can afford the payment.
The banks, credit card companies and lending intitutions have taken full advantage of our ego's and stupidity. While standing in line at the store, I watched the person in front of me asking for cigaretts. She pulled out her plastic and the cashier said "debit or credit?" "Credit" she said.
We have overextended ourselves to the point that no one can back us any longer. So who is to blame for the econimic crisis? We all are. The politicians, the bankers, the fat cats on wall street and we, the people.
"I hope congress does not bail out Wall Street and that this country goes into a depression."
Talk about cutting off your nose to spite your face! I suggest you do a little reading about the Great Depression or better yet talk to someone who lived through it or has parents who lived through it.
You really, really, really don't want to go there.
A depression doesn't mean "We don't get a bigger house". It doesn't mean "We don't get a new car".
It means you lose your house, and your job, and your car, and your bank account and go live in a tin/plywood shanty like a third-world refugee while standing in a soup line for a handout.
During the Great Depression my grandfather had to walk the railroad tracks to pick up coal left by the trains so that they could have heat.
Both are right.
My father, who would have been CFO of GMAC had his health been good, sold vacuum cleaners door to door.
Maybe we should all walk a few tracks. Your Grandfather found a way to support his family. I'm sure we could too. Life on easy street is over as we know it. It's time for everyone to put their nose to the grindstone and take responsibilty for themselves.
It appears to me this is like taking out a second mortgage on one's home, but the bank allows you to leverage double of triple the value of the home because they are counting on the value increasing steadily. Then with the massive job losses at all levels, air line pilots, waitresses, bankers, realtors etc, the incomes that once were enough to sustain were now gone. Our "Boom" economy created only 5.5 million jobs!
How many have we lost, where is that number, we lost 604,000 this year so far, and more are on the way.
Jobless Americans cannot buy anything, cannot pay mortgages, or take a trip to the Laundromat or the convenience store. Or even the grocery store.
This, in a consumer driven economy?
My understanding is that these Bush era jobs overall are of less quality and pay way less. (actually I am living it) Higher worker productivity, less overall wages, but of course everything cost more now.
Occupancy is the key with real estate values, stop foreclosures for 6 months to a few years, force re negotiation out of those bad loans into affordable rates and payments...let them pay what they can if they have a job, do not put a paying customer on the street if it can be avoided and we can work our way back up the ladder.
Finally, someone "GETs" it. The US has experienced MASSIVE job losses and the only jobs we are creating are service related jobs with minimum wage pay. I read an article earlier this year that stated that the number of citizens applying for Food Stamps is at higher in 2008 than in any year since its existence. 700 billion dollars to Wall Street is not going to halt the downward financial spiral the US is experiencing. They need to invest that 700 billion dollars into JOB CREATION.
Good post! If Bush is willing to bailout Wall Street then perhaps understanding Main Street made a error in judgement purchasing that home should be a consideration too. Maybe some can afford the home if their mortgage is re-negotiated. Somehow I think the solution to this HUGE mess that somethin should be done for all concerned.
The main cause is not the deflation of the housing bubble. Markets always go up an and down. That's to be expected. The cause was that there were no standards for loaning people money. People were permitted to borrow more than they safely could handle, and loans were given without the borrower having any financial stake in the transaction, and loans were given that were greater than the collateral that backed them up.
If loans were made properly, we could have suffered this downturn without any of these consequences. The cause of this crisis squarely falls on the back on poor risk management and the feds attempt to rescue the 2000 market crash on the backs of consumers.
exactly my sentiments. the lenders are responsible for their own risk management. In this case they were only concerned with earning a fast commission, and then selling the mortgage on as quickly as possible - they completely ignored the risk.
I am a non risky mortgage holder, but I'm now standing knee deep in manure as a result of the mortgage industry's predatory lending practices. My home, here in northern Georgia, is worth - in real terms - significantly more than when I bought it. But since the market has been poisoned no-one wants to pay anything realistic for a home. I'm currently sitting on a net loss - after I pay for fees and deduct the additional equity I've since invested in my home. We got word of an offer last week - they wanted to pay less than 90% of the price that I paid - and that's before I spent another $100k on the upgrades and improvements!
I'm talking about $90 per square foot here! Not some hyper-inflated bubble price in excess of $500 per sq ft. And this is in a gated community with fabulous facilities!
I may - in the end - simply sell this at a huge loss and leave this country for good. If McCain gets elected that will be the sensible option.
A house is a shelter, not an investment. Yes, it amounts to an investment if you live there long enough. For example, in the old days [10-30 years ago] people lived in their houses for at least 15-25 years and made mortgage payments they could afford. As the prices of their homes rose, they were able to accumulate equity, so that when they ultimately sold their house [typically after retirement] they were able to finance the purchase of a retirement house and have a few bucks left over to spend.
Nowadays, people buy a home and expect to get instantly rich in just a few years! It does not work that way. Hang onto your house for another 15-30 years, or at least until you have paid off your mortgage, and you will find your home is indeed worth a lot more.
Actually, if the loans were made properly, we wouldn't have HAD this massive downturn. It was all part of the "prosperity" plan - dump tons of money into the economy by government borrowing and individual borrowing-against-equity.
In order for this to work, housing prices HAD to be driven upwards, which only happens when there's an excess of buyers. How do you get an excess of buyers? Simple, just loan money to people who really can't afford it.
Bush's mistake was that he mis-timed it. The disaster wasn't supposed to happen until after November, so the Democrats would get blamed. But once you get greed rolling, it's hard to stop.
As a Realtor, when you apply for a loan, the criteria is virtually the same across the board with all financial institutions. The problem is banks discovered a way to make more money - ensure within 27 months, you HAD to refinance. Loan Officers received bonuses when they secured an ARM versus a Fixed rate loan and the ARMs were what was promoted. If you are not a saavy buyer, you were a potential target. Unfortunately, no one exhibited the foresight to acknowledge that during the Bush Administration, every industry across a myriad of sectors have experienced massive job losses. Therefore, don't display a preconceived notion that the banks were handing out homes like candy - they had the same stipulations but they knowingly encouraged predatory lending practices.
"Almost every economist I know rejects the Paulson approach and argues instead for directly injecting capital into the banks. The taxpayers give them the money and then we own some, or all, of the bank."
Sensible and straight forward! Why aren't more proposals being put on the table?
But you just argued that banks won't lend because consumers don't have equity intheir houses, so it doesn't matter if the capital is directly injected or created by wiping debt (and hence reserves for debt) off the books of banks. Neither would work according the analysis here.
As I hear it, there are people who want loans who can't get them. So the problem isn't consumers who don't want to borrow. People have borrowed for auto loans and college loans before the housing crisis. They just didn't use their home equity as security. I've never taken out an auto loan using my home equity as security. So that analysis doesn't hold up.
Take the $700B figure, payoff the mortgages up to $250K each via contract terms administered by the banks. If homeowner A has a $100K mortgage, that's the amount paid. If homeowner B has a $300K mortgage, $250K is paid off. Think refinance with a mortgage whose first payment isn't due for 10 years, no interest accruing until the repayment start date. For 10 years the property can't be sold, transferred, or put into bankruptcy without triggering an immediate repayment provision which includes a 10% penalty and 10% interest. (Banks can foreclose and the government guarantee the sale.) In return, the homeowner uses the money he saves for the mortgage to pay off his existing debts, verified by a bank credit check, and have enough money to buy goods and services again. The banks would be made whole, the consumers would have some money to spend and put back into the economy, the credit debt limit would be reduced, and companies would profit which benefits Wall Street. The homeowner is given a breather. After 10 years, the bail out converts to a mortgage with a 5% interest rate payable over 15 years. Trickle-up economics. Beats giving the fat cats $700B that will never be repaid and watching the take their money and laugh at the taxpayer like Big Oil did after Katrina and the airlines did after 9/11.
Great solution, I like it !
I have another simple solution too!
We are told that the problem here is that the system is filled with
"toxic" home loans that are not worth what they once were.
They are "toxic" because they are going into foreclosure , not because the houses are worth less now than a year ago, but rather because the loan's interest rates have reset and the homeowners payment has quadrupled overnight. Its the rise in payments that is causing the foreclosures, not the falling value of the houses.
The solution is easy. Take the 700 billion and offer 30 year fixed rate home loans at a low interest rate.
How bout maybe a few different programs that take into consideration someone's FICO score:
3% if you have over a 700 FICO score, 4% if under 700, 5% if under 600 , 6% if under 500.
Also, set up a program for business loans, and start them out at 8%
Maybe have a few different rates for business loans the same as home mortgagees using
some kind of credit report, or, size of their annual receipts.
The investment banks get their original investment back.
The homeowner gets to keep their house
The foreclosure problem goes away.
Not a penny to the wall street wizards that brought us this problem in the first place.
We did this in the 1930's, and it didn't cost the taxpayers a cent.
We can do it again.
I like your idea, too. In fact, I like yours better than mine. My only problem would be with the FICO score because it relies heavily on the accuracy of the credit reports. I recently pulled my own credit report and my one mortgage was counted 83 times. Talk about loan to value disaster!! 2 Months and lots of correspondence later, my reports are now correct. Every year we find errors on our reports even though we haven't made any changes in the last 3 years. (So folks, pull your free reports now and check them very carefully.) Sadly, I'm afraid Congress is just going to give away the store to Wall Street, with or without our consent if not before the election, then after it. I don't know if they have tunnel vision where special interests are concerned or if they just don't trust the middle class and poor to do the right thing.
In other words, reward irresponsible homeowners who bought houses they could never afford? On MY tax dollars? Those same tax dollars that I generated after working hard, SAVING, buying within my means and acting responsibly?? Sure, I'd support this measure if the government eliminated my taxes for the same amount of time, and/or gave me $250,000 also!
My solution is for all taxpayers, you included. Some fault does lie with some borrowers, but overall borrowers did not walk into the bank and demand that loan officers give them mortgages at 5 times their salaries and at 5 times the assessed value of their homes. The fact that shady lenders told borrowers that they could afford more than their homes were worth (125% loan to value) and could make payments based on low ARMs which readjust skyward in a year or so. Many people trusted these lenders; after all, they were the ones who are supposed to know about finance and market value more than the average person. Then these questionable loans were sold on the secondary market where no one really cared as long as they made a profit during the real estate boom. Then boom went bust, our government borrowed heavily from other countries, and didn't say a whole lot about this mess until it spun out of control. Reality is there are many greedy and/or inept bad actors who created this crisis. The answer may not even be a bail out. My first question is whom do I trust followed by where do we start? Based on history, I certainly don't trust Wall Street to do the right thing for anyone other than their executives.
You must be logged in to comment. Log in or connect with
