While I think I'm a fairly smart guy, and I've taken at least a handful of economics classes, I am hardly an expert in finance. That said, the root of the problem facing the banks seems clear to me, as does the solution. The problem with the bailout proposal is it fails to address the root causes of this crisis. It's a Band-Aid, at best.
As I wrote above, I'm no expert, but the outlines of the situation seem relatively simple to me. The problem is that banks and other financial institutions are holding bad debts. They want to unload them, precisely because they are bad debts. However, no one wants to buy them, because they have little or no value. The solution to the banks' problem is not to just buy them out -- we should try to turn these bad debts into good debts.
Where/how did this crisis start? With the collapse of the sub-prime lenders. According to the experts, this set off a chain reaction of tightening credit, and left many financial institutions in a cash-poor situation. Without adequate reserves, their Ponzi scheme pyramid financing began to collapse around them. Remember, though, that the root of this problem is still the fact that too many institutions are holding mortgage notes that are way in excess of the equity of the assets -- the homes that are being securitized.
The main reason people started defaulting on their mortgages en masse is that their variable rates skyrocketed. I'd argue one more point -- the whole problem was exacerbated by the truly usurious rates and larcenous fees that the banks are collecting on credit cards. If credit card rates hadn't doubled or tripled for most consumers, they would have been in a better position to weather any increases in the mortgage rate. Moreover, the banks holding those loans wouldn't have felt the pressure to hike the rates in the first place. With consumers failing to meet their consumer debt obligations, the banks started to look at the real estate assets to generate more revenues. It was a vicious downward-spiraling cycle.
Some here would argue that the solution is to simply let the market sort it out. Let the banks suffer the consequences of their own misjudgments. To me, the risks attendant to that line of inaction are far too great. The whole economy really could start unraveling in the same way that the run on banks in '29 set off a chain reaction and a decade-long Great Depression. To me, this is no solution, at all. There is, however, a course of action that I think will address the root causes of the problem, and allow the federal government the room to bolster the position of the financial sector.
The solution?? Roll back those rates -- by legislative fiat, or by some other incentives. The bailout, according to most economists, will actually work to raise the interest rates on consumer debt. This seems like a perverse outcome to me, and one that will leave all the systemic problems in place. So long as these lending institutions continue to charge rates that would make a loan shark blush, there is little chance of ever turning those bad debts into affordable "good debt". The current rates just mean that borrowers are falling further and further behind, just based on the accumulating interest.
We can save the banks from the consequences of their own greed, if we can bolster the ability of consumers to pay off their debts -- mortgages and credit cards alike. In fact, we can save the banks, improve the lot of the American worker/consumer and strengthen John McCain's beloved "fundamentals" of the economy, all in one fell swoop.
Under George Bush's "leadership", the Congress raised the ceiling on the rates credit card companies can charge their customers. Congress can act to change that back again. Some in Congress are looking at the mortgage issue. I think they need to also look at the past loosening of rules for credit card companies -- to consider the roles these changes played in creating this crisis, and insisting on consumer-friendly changes that will address the root cause of this crisis.
With the Bush Administration anxious to gain Democratic support for its bail-out proposal, Congress will never have more leverage than it has now -- to drastically cut the allowable rates, and to force refinancing of sky-high adjustable rate mortgages.
Roll back the rates, and much of that bad debt will magically transform into strong assets. American workers will once again begin to pay down their debts, capital will begin to flow, and consumer spending may even rebound in short order. I can't think of anything which could produce these salutary results in a relatively short period of time, other than my proposed drastic reduction in consumer credit and mortgage interest rates.
As for the politics of this proposal, can anyone think of something that Congress could do that would be more politically popular? While the financial industry might chafe against these restrictions and cry "foul", they are hardly in a position to win that fight. Moreover, in the long run, I believe they will emerge with stronger financial positions. Not only is this a win-win idea, I think it's the only thing that can make a difference in the long-run.