I'm an economist from New Mexico. My friends have teased me for years because they claim that I not only understand this stuff, but can actually teach others about free market principles and corresponding theories.
Let's get right to the point. The Bush administration's federal bailout proposal, as furthered by Treasury Secretary Paulson, will not work; in fact, it will make our financial crisis even worse.
As with many of the current administration's plans, this proposal is flawed due to its top down approach. Bush and his Republican ideologues believe that stimulating the most wealthy will lead to economic gains that will trickle down to Main Street. Companies considered "to big to fail" will receive the lion's share of the proposed $700 billion package. Yet it is the little guy, the family living on Main Street and considered by Bush followers as "too small to save," who will rescue the nation from the grips of a Second Great Depression.
Since coming to office, Bush has focused his tax relief on those at the top. While trillions of dollars have been channeled to the most wealthy, the economy has performed miserably. Under eight years of Clinton stewardship, American businesses generated over 20 million new jobs. In contrast, Bush's Republican ideology has squeezed job creation growth to about five million net positions.
Bush's flawed ideology fueled a tragic insurgency in Iraq as well. The administration's plan sent too few troops into the theater, allowing our military to focus only on Saddam and his henchmen (remember the playing cards of bad guys), while leaving tens of thousands of Bathist officials and military personnel without money or dignity.
This is not the appropriate forum to debate the pros and cons of top down v. bottom up solutions, but let me give you an example of how our leaders become captured by their own rhetoric and political biases.
A number of years ago, I read a story about a delivery truck that had become wedged under a low handing freeway structure. The clearance was posted as 12 feet, but the truck actually measured 12 feet two inches. It passed under the structure for a few feet, but became wedged part way through.
City officials and their top engineers climbed ladders to inspect the dilemma. They measured the truck and freeway clearance numerous times. They discussed possibilities of bringing in hydraulic jacks to lift the structure and free the truck.
While the "experts" pondered their options, a young boy on a bike stopped by to watch the spectacle. He listened for 15-20 minutes as the engineers argued over the best way to lift the low hanging freeway.
Finally, the curious boy walked up to one of the city officials and asked a simple question, "Why don't you let some of the air out of the tires on the truck?"
The experts focused on the top down approach, while all along the solution was right at hand from a bottom up perspective. It took a child's mind to come up with the most practical and effective solution.
Our "experts" in Washington are trying to lift the low hanging freeway structure. Their proposal hopes to take the economic pressure off the shoulders of leading financial firms on Wall Street. They want to buy up all the bad debt hemorrhaging in our economic system.
One of the best summaries of our current situation comes from Devilstower
http://www.dailykos.com/...
This blogger captured the key ingredients of this financial meltdown. Borrowing on the research of Bob Moon and Kai Ryssday, American Public Media's Marketplace, Devilstower lists some key economic figures:
The value of the entire U.S. Treasuries market: $4.5 trillion.
The value of the entire mortgage market: $7 trillion.
The size of the U.S. stock market: $22 trillion.
The size of the credit default swap market last year: $45 trillion.
We know today that the $4.5 trillion U.S. Treasuries market is healthy. The $22 trillion invested in the U.S. stock market, while clearly suffering a bronchial infection, is fundamentally stable.
It is the estimated $7 trillion mortgage market, due to the bursting housing bubble, where the root of the problem lies. The defaults and lack of confidence in these investor IOUs are creating unprecedented insecurities in the credit default swap market (CDS), which is believed to be closer to $70 trillion today that the estimated $45 trillion.
This is where the top of the truck has become wedged under the low hanging freeway structure. While national experts measure and re-measure the truck and freeway overpass, they propose to lift the structure with a cash infusion of $700 billion to buy up the bad debt.
In this top down approach, the $700 billion becomes a paltry drop in the bucket of the $70 trillion in CDS obligations. It is approximately 1/1000th of the total. This is like paying $1 (one dollar) toward a debt of $1,000 (one thousand dollars). The single dollar does little to instill confidence that one can eventually repay the obligation. Conversely, this additional, but ineffective, infusion of dollars in the market will likely fuel inflation and decrease the value of the dollar in world markets.
The solution? We must let the air out of the truck tires. The solution isn't to save the $70 trillion CDS market; the solution doesn't rest with the entire $7 trillion mortgage market. The problem stems from the bad commercial paper that is circulating in the global economic system.
While the Bush administration, under the direction of Secretary Paulson, wants to find the "insurgent" paper -- needles in haystacks -- and remove it from the system by authorizing the federal government to buy it, the solution is to prevent any more commercial paper from becoming "bad."
This solution will not be pain free. There are no good options left at this time. Yet the federal government must initiate a ground up rescue. By preventing foreclosures, halting bankruptcies, the paper IOUs at the bottom of the commercial credit food chain will remain viable. If the foundation remains strong, then the subsequent levels of securities IOUs will remain solvent as well. Ultimately, this is an issue of confidence. If a domino at the bottom collapses, it will take others with it. As Wall Street firms have leveraged their obligations 20-30 times (or more), the fall of a single domino causes a chain reaction throughout the entire global financial community.
Bush and Paulson want to find and buy back the bad paper within a seething network of $70 trillion worth of obligations. Good luck! By stopping the bleeding at the source, with the little guy on Main Street, confidence is restored. Increased margin calls are no longer necessary. Capital is infused into the system at the most effective point -- the bottom.
And, just as one default can multiply through the system 20-30 times, each secured mortgage multiplies confidence upward through the network. The global panic and potential financial meltdown is averted and capital begins to loosen up and flow freely again.
By putting billions of dollars into the hands of Main Street Americans who are in trouble, turbulence in the markets will be calmed. The initial $150 billion infusion in relief by the Bush administration went to everyone. It wasn't focused. Families in need couldn't prevent their collapse with a one-time check for $600 or $1,200. Families doing well didn't need the money. Struggling households must be rescued and saved from mortgage default and bankruptcy. If their IOU remains good, all IOUs up the chain remain structurally sound. Confidence is restored.
Let the air out of the tires of this runaway truck or suffer the collapse of the entire financial freeway system.