I have been writing the content for a web site called The Bailout Blog for a client in California. The bailout has been the subject of numerous headlines, talk shows and opinion pieces. Most Americans very likely don’t fully understand the bailout, but have an opinion based on the headlines.
The bailout certainly has its pluses and minuses and is far more complex than the average taxpayer could understand. It requires an understanding of the markets and a historical perspective that only the best economists possess.
The premise of the bailout is simple. We are a credit-based economy. Individuals rely on credit cards to make purchases, to get advances and as a convenient way of conducting commerce on the Internet. Companies need credit for a number of reasons including purchasing supplies, funding special projects and advertising. When credit is not free-flowing; problems ensue.
Last October, when the bailout was initiated, our credit markets were at a virtual standstill. This was hurting businesses and consumers alike. The net effect on the economy was decidedly negative and the subsequent job losses have been only one indicator of frozen credit.
One has to understand that the Secretary of the Treasury and the Chairman of the Federal Reserve are smart people. So are the hundreds of economists, accountants and financial service experts they surround themselves with. The steps they initiated in October were not simply knee-jerk, but based on what we learned from America in the thirties and the theories of some of the most respected economists of the past seventy years.
The original purpose of the bailout funds was to inject cash into the frozen credit markets. Banks, hard hit by losses in the mortgage markets, had all but stopped lending money. They were instead, desperately holding on to capital. The only way to encourage banks to start lending again was to provide funds to do so and to instill confidence in those lenders that they had a cash reserve.
The other concern of the Treasury Department, Federal Reserve and FDIC was the escalating number of foreclosures. This problem, due to the subprime loan crisis and adjustable rate mortgages combined with falling home values, was threatening to have a ripple effect throughout the economy. The three agencies combined their efforts to help homeowners with loan modifications to reduce the number of foreclosures and help the banks with this process.
The mortgage meltdown already had a ripple effect. Tens of thousands of securities derived from mortgages are held in mutual funds, hedge funds and in other forms. This has caused an enormous problem on two fronts. First, it has devalued these securities, which has led to the failure of the funds that hold them and even the financial firms who have held a big stake in these derivative securities. Secondly, when mortgage terms have to be restructured, it makes it difficult to get the approval of the mortgage owner when the mortgage itself has been sold and then sliced up into derivative securities.
Beyond the bailout help for the banks and financial institutions, a line formed, which included the domestic automakers, several states and a number of other industries hard hit by the economic slowdown. The new administration will apparently have control over the remaining funds and will have the new Treasury Secretary distribute those funds as he sees fit.
It should be understood that the government is not just handing out funds without anything in return. While there is some dispute about the stipulations attached to the funds disbursed and the eventual use of the funds, the government is getting preferred stock and warrants in return. Could the government eventually make a profit on their loans? Possibly.
In the seventies, the government loaned Chrysler Corporation funds to keep the automaker from going under. The government eventually made a $660 million profit on their investment. That will likely not be the case today with the Detroit automakers, but some of the loans to banks and financial institutions could prove to be a wise investment. The economy moves in cycles and many of these businesses have the potential to be profitable again.
The downside to this entire scenario is that it adds to our national deficit. Unless all of the loans are paid back, and additional value is derived from the investments in the financial firms, our children could be bearing the brunt of our financial problems. Whether or not the bailout was prudent is yet to be seen.
With unemployment projected to be near 10% later this year or next, the bailout will most likely have prevented even worse numbers from being a reality. During the Great Depression, unemployment stood at 25%. The bailout won’t make everything good again right away, but it has the potential to move the economy back in the right direction. Recessions generally run from 14 to 16 months and the current one began in December 2007. While some experts foresee tough times through the end of 2010, the bailout may have kept that date from being two or three years later.
Hold onto your hats…………..better days are ahead.
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