Dr. Jillian T. Weiss

What is the $700 billion for?

Filed By Dr. Jillian T. Weiss | September 25, 2008 8:00 AM | comments

Filed in: Living
Tags: bank robbers, economic policy, finance industry, financial crisis, government bailout, personal finances, Wall Street, Wall Street bailout

There has been a lot of discussion lately about whether the $700 billion bailout is a good idea or not. On one side, the Bush administration is saying that the economy will come apart like a cheap house of cards if the bailout is not approved immediately, if not sooner. On the other hand, critics are saying that this is rampant socialism for the wealthy, rewards bad risk takers and CEO's with billions in golden parachutes, and is totally undefined in the 3-page bill shoved at the Congress.

But I have heard little discussion about what the bailout proposal actually is. Yesterday on Bilerico, Bo Shuff proposed a Trickle-Up Bailout. It was an intriguing idea. But it would help if we understand what the $700 billion is for.

Is it true that the money is going to be given to finance companies that engaged in risky speculation?

No. But it's just as bad. The bailout proposal is not about giving money directly to the finance firms with bad debt, nor paying off their debt. Rather, the idea is buying assets from the finance companies.

A bridge for sale

These assets, mostly real estate, which secure money lent by the finance companies, are no longer worth enough to cover the loans because the housing market imploded and is not likely to revive for years. As a result, the finance companies will have to sell off these properties at bargain basement prices, and write most of these loans off as losses. That means the finance companies will have little money to lend. Without money to lend, businesses will be restricted to working with the cash they have on hand. That means every kind of business will slow down.

Thus, the bailout proposal is for the taxpayers to buy the assets from the finance companies. This will give the finance companies money to lend, and keep the wheels of the economy moving. Meanwhile, the properties purchased by the taxpayers will be held on the books until the housing market revives, and they can then be sold at a profit. So the taxpayers will make a profit from the bailout. At least in theory.

The problem is that investing in real estate is a risky proposition. Over time, real estate tends to increase in value. A lot. So you can make money by buying real estate. A lot. But you can also lose your shirt. It can tie up your money for a long, long, long time. And it needs to have money spent on it, because if you don't maintain it, it loses value instead of gaining value. There is a reason why buying a house is called a "money pit." So what the bailout is really doing is gambling with your money. It's equivalent to raising the stakes in poker. If you can get your opponent to fold, you win the whole pot. If not -- well, you just threw away some real money. A lot.

The $700 billion bailout is supposedly a good deal for taxpayers, because they are buying assets that are worth a little now, but will be worth a lot more later. Right. This assumes, as does every good Ponzi scheme and confidence trickster, that the market will go up enough quickly enough to allow you to sell before the accumulating costs of the properties and your other obligations put you under water. Remember, the people selling us these bridges got into trouble by putting blue sky prices on them and then extending too much in loans on these inflated prices. Are they going to sell it to us for the same inflated prices? How much of a discount will we, the taxpayers, get? Scuba anyone?

The Derivatives Mess

Complicating this is the "derivative" market, featuring the "credit default swap." This is an ingenious scheme, inevitably described on TV and radio as too complicated to describe. It was designed by boiler-room hucksters to get more money for finance companies selling risky mortgage-backed securities. It's basically an insurance scheme, similiar to the insurance on your house or your life. Except not as good. The idea is that when finance companies sell these risky mortgage-backed securities, they offer the buyers a "swap". The "swap" is a contract that says "if there is a default on these securities, we will step in and pay you instead." The finance company gets a premium and the buyer gets reduced risk. Everybody is happy.

There is problem here, however. Usually, only a small percentage of people holding insurance make a claim. But insurance companies are regulated so that they have enough cash to pay all claims even if there should be some sort of unanticipated wide-spread disaster. If there were no such regulations, greedy insurance companies might sell insurance like mad, ignore the need to squirrel away money to pay off claims, and hope that there would no run of claims. Well, there were no such regulations on the credit swaps, because regulators exempted them from being called "insurance." Now, there are $62 trillion in swaps (I am not exaggerating) out there. So once the defaults start happening, these swaps will come due, and the economy will come apart like the cheap house of cards that it is.

Buy now, pay later, this offer will not last long!!!

We are being rushed to do this. But this is not a good deal for the taxpayer. The $700 billion will stave off crisis for a time. But, looking at the facts, it is likely the economy will go BOOM! sooner or later. No one wants to believe that, particularly those with money in the stock market, or who sell stocks, or who want everything to be rosy (or their politicians). But if the economy goes BOOM! now, then the Republicans will surely lose power.

It is ironic that the Bush administration has been insisting, until last week, that the economy is fine, and that naysayers are anti-American. Now, the economy is suddenly about to suffer an unforeseen and sudden implosion. Anyone who opposes the bailout for this terribly ailing economy is anti-American, and "playing politics" (because the Republicans will lose if the economy is the #1 issue). That's why President Bush is pushing like crazy for the bailout. Now now now now now!


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Robert Ganshorn Robert Ganshorn | September 25, 2008 9:43 AM

"bomb, bomb, bomb, drill, drill drill" they do have a tendency to repeat words in multiples you know.

In addition to the folks that were sold a vat of snake oil on the promise that the asset would increase in value before the bill came due are the cold blooded speculators who, (in the case of Florida where I have knowledge) would walk in to a condo office and purchase pre construction ten units at a crack on a margin. Florida, Arizona, Nevada, California also had people who would purchase five houses at a time on a margin to flip them for a profit in six months. Like many a confidence scheme these people did make a lot of money at the start and are now in debtors prison.

Sounds similar to buying "on the margin" in Wall Street pre 1929 doesn't it?

A mechanism is needed to keep individuals in their homes with a refi as much as possible so that they will be maintained. Forget about helping speculators because they deserve the fruits of their greed. Golden parachutes?, no, prison time for the pirates who evaded our too lax regulation. There are laws already on the books that have been broken.

What I do know is that our industries have to compete on a world market or we are sunk. When well capitalized internationals like Caterpillar Corp have to pay 7 1/2 % for money now (3 1/2% last week) and GM no longer has any credit available to it, we are just weeks away from massive unemployment and factory shutdowns. The legislators, for once, must work both quickly and smart because without our manufacturing base "Boom" is before the election.

And then, Japan, China, India, the Arab oil producing countries (and to a lesser degree Britain) will buy up American banks assets and industry at bargain prices. They have plenty of dollars in their central banks that they keep from oil proceeds and to purchase oil (foreign banks keep dollars on had to buy oil)which will lead to a "basket of currency" price for oil and the return of many dollars to the USA with corresponding inflation.

Dr. Weiss, thank you for this thoughtful article. If you feel I am missing the boat on this line of reasoning please let me know.

This is a great summary.

I think that every American absolutely needs to understand why and how we got to where we are. The central feature in this crisis is the absolute failure of conservative ideology, that is that deregulation makes the market solvent of... well, everything.

The derivatives mess it indicative of how, left to their own devices, private actors will cheat each other until the world collapses around them. 62 trillion? That's bigger than the entire world's GDP for 2007, right?

This whole thing is insane, but we can't let people get away with saying it's too difficult to explain and then just not explain it. It's complicated, but people can understand the basic ideas, and they're looking for answers.

The whole damned thing is confusing - which is what they are playing off of. They hope most Americans won't know what the hell they're talking about and will blindly trust the government.

To quote my good friend Steph:

Fuck that noise. I'd like to opt out of this new Great Depression, please. I did nothing wrong. I'm not fucking around on Wall Street. I'm not taking out loans I can't pay back, or handing out loans I can't back. Why the fuck should this affect me? Let the shitheads responsible pay 700 billion dollars, or whatever made up number they're throwing around.

I would remind Steph and all of us that we are in this boat together. Just because the hole is under their seat doesn't mean we're not going down. We're going to have to try to seal the hole and kick ass later. The real problem here is that our memories only last about 10 years. The S&L crisis ended in 91. Then the Republicans went and passed a law that allowed the rowdy frat boys of Wall Street to re-arm with axes and saws, and they immediately went to work on making a hole under their seat. The majority of the American people applauded and cheered, and gave them all their money. (Great timeline over at Wikipedia.) de Tocqueville said that “in a democracy, the people get the government they deserve.” It's time for the people to rise up or shut up.

She'll be guest posting today, Jillian. You'll get that opportunity to tell her. LOL

It's not confusing, it's obvious what's going on. What you are now seeing is a Robin Hood gig in reverse. If Bush and Paulson and the Congress want to nationalize Wall Street's debt by having us eat it through taxes (and worse), then why not lobby, demand, protest to have it paid off by nationalizing their profits instead? They broke it, they bought it.