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!