Wednesday, November 19, 2008

Not the Bailout We Bargained For

Robert Reich writes A Bottom-Up Bailout Rather Than Trickle-Down which is a far too polite title for a post that describes the crap that's happening with the bailout money.

"Hank Paulson has just about burned through $300 billion, and it's not clear what the public has got out of it. Perhaps things would be worse without the bailout but they're certainly no better. Wall Street banks have not significantly stepped up their loans to small businesses, college students, car buyers, or distressed homeowners. Much of the auto industry is on the verge of bankruptcy. And the rate of foreclosures is rising.

What happened to all the money? About a third has gone into dividends the banks are paying their shareholders. Some of the rest into executive salaries and bonuses. Another portion toward acquisitions designed to raise share values. Another chunk for bailing out giant insurer, AIG."


Anonymous said...

Starch wrote:

I really don’t understand what’s going on. I understand we shouldn’t trust “market forces” or “greedy CEOs” to fix the down-turn, but I don’t understand how it’s possible keep housing prices elevated if people can’t borrow money with the same relaxed criteria as previous years.

If interest rates are increasing as a result of deficit spending, and rising interest rates are causing people to default on home loans. Borrowing more money from other courtiers to “fix the economy” will actually make the situation worse. Regardless of whom trillions of dollars are given to.

Further, I don’t know who people are expecting to step up and buy houses at lat year’s prices if the government does manage to prop them up through deficit spending. Assuming it’s really harder to borrow money this year than last (for home buys or the U.S. government), and the supply of houses is constant, prices must fall.

I think the U.S. treasury understands all this, and bent the truth in front of congress to get enough money to preserving the U.S. as the world’s financial leader. This was the real risk if major U.S. banks failed (China & Russia still have plenty of money). No doubt the treasury was hoping bank leaders would be smarter then get caught going to resorts and spending heir new billions buying rivals, but there’s not reason they should change after getting such a large present.

Howard said...

You might be a few steps ahead of me, but I don't follow what you're saying.

Interest rates are being lowered by the fed to stimulate the economy, unfortunately they are already low so it's hard to go lower.

People are defaulting because their non-fixed mortgage rates are rising as they were scheduled to do even though the borrowers didn't understand . Previously if rates rose, borrowers would refinance, but since housing prices fell they can no longer refinance because their asset didn't magically rise in value.

The fed's original plan was to buy the toxic assets at higher rates than they are currently worth which would give the banks more money and remove their bad debt. The government said somehow that they were smart enough to figure out which toxic loans weren't really toxic so that it wouldn't be a total loss, the newly owned mortgages would really be worth something and could be resold so the taxpayer got their money back, but I never followed why the gov't thought they were better at valuing mortgages than the expert mortgage lenders, but ok.

But as I thought I understood, the real problem was that banks weren't lending because they were overleveraged due to the bad debt. They are allowed to loan at a 10:1 ratio but since they didn't know what their assets were really worth it was more like 20:1. Buying toxic debt would reduce the 20 part but it's more efficient to buy an equity stake in the bank which would increase the 1 part which would be a more efficient use of the funds. Once it got back to 10:1 banks would start loaning. (my numbers are made up but I've seen them used before).

But now I read that the fed buying equity isn't what was supposed to happen. I think that's right but it was the preferred plan and was inserted into TARP at the last minute, so it's legal. But clearly the money wasn't supposed to go to paying dividends.

I don't think the goal was to ever prop up housing prices. They were high and needed to fall. The problem is defaulting mortgages that were used to back derivatives that all the financial firms bought not expecting them to default and not understanding the risk. The problem is proping up home prices now, it's preventing the defaults.

Also, as near as I can tell the rest of the world (including China and Russia) are also having problems. They don't have the huge debt that we did so their problems are different, but if we're not buying everything they make, they have to stop making things.

I don't (yet) think the fed or treasury dept have been scheming to syphon money to their wall street friends, but they do seem to be thinking a few steps behind and wall street could stand to be a little less greedy and a little more altruistic. I know it's not their nature, but it would help them in the long and medium run, not just the short term.

Please correct me where I'm wrong. :)

Anonymous said...

Starch answered:

I think we’re heading down the same path, so let’s continue:

The banks that accumulated bundled mortgages insured them with each other and investment companies like AIG as “default swaps” (multiple times in some cases). They were careful not to call these transactions as “insurance policies” as law requires more capital to back up “insurance policies” than deregulated “default swap”. Because the banks are all tied together and see the treasury riding to their rescue, they don’t need to limit the rate of foreclosures or stop going to spas.

The treasury has made the decision to use the bailout money to save U.S. companies, rather than the home owners who will still be foreclosed on. The story being sold by congress and the press that the bailout money will be used to save homeowners and stabilize housing prices, do not jibe with the events which are occurring. Though to be honest the treasury might realize buying “toxic assets” is a net loss, and they are trying to break even on this deal.

I’m ok with all of this. What bothers me is what I was trying to explain earlier: using our present and future tax money to saving U.S. companies is a mistake. I don’t care who owns the bank I use or what brand of car I drive. I care about increasing taxes and recessions, both of which I believe are fueled by deficit spending.