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I'm writing to add my voice to the many talking about the financial crisis.  First, let me tell you that I am a grad student in economics.  I say this for two reasons:  1) though I don't understand everything going on, I probably understand more about it than the average person, and 2) as a grad student, I'm relatively poor and therefore don't have ulterior motives.  The latter point seems to matter here as some have accused anyone in favor of the bailout as having a financial motive for our view.

I understand that we've been burned as a nation by an administration that is quick to claim that Armageddon is just around the corner.  However, this IS a very serious problem.  There is one thing that we need to get straight: if congress does nothing, everyone will suffer.  While I doubt the economy will get as bad as the Great Depression, there is a fair chance that it will be the worst downturn since that era.  It may not happen tomorrow, but the more we wait, the greater the chance of a meltdown.  Also, understand that the small recovery in stock prices today is based on optimism that congress will pass something.

More after the fold...

There was a diary yesterday explaining the situation, but I'm going to take it from a different approach.  Remember the scene in "It's a Wonderful Life," where there's a run on the bank, and George Bailey tells the clients that he can't give back the money b/c it's been used to buy houses for other townspeople?

Now imagine if people took their money out anyway.  No more mortgages.  No more car loans.  No more small business loans.  This is what is happening right now, except is wasn't caused by a run on banks.  Banks gave out mortgages for more than the value of homes (plenty of blame to go around for that).  If people don't pay off the loans, the banks will get the property, which is less than the money they gave out.  They have to just write off the loss.  The money you put into your savings accounts, that banks normally use to give out loans, is GONE.  It was used to give mortgages that should never have been given.

So, now what do we do?  Well, we can continue to blame the people that got us into this mess and laugh at how they try to blame us.  We can punish Wall Street and by doing so, punish "Main Street" in the process... Or we can support some sort of bailout plan.  The bill that failed was certainly flawed.  I would love to see a version that puts less power in Paulson's hands, and would give more equity to taxpayers, but I would have settled for the bill that failed.  Here's why:  the bill is not meant to be a solution.  After we avert disaster, we need to step back and address the problems that got us here.  I think President Obama, w/ support from a more Democratic congress can do that.  This is what you should be focussing on when you contact your reps.  Keep the pressure on them so that we don't keep getting into these messes.  The deregulation that started w/ Reagan but continued through several other administrations needs to be reversed.  However, that's not what the bailout is about.  The bailout is meant to get capital to flow again.

I understand the philosophy that government shouldn't be responsible for bailing out Wall Street's mess.  I don't agree w/ it, but I understand.  However, I want all of those w/ this position to understand that it will be VERY bad for the economy.

Originally posted to khassani on Tue Sep 30, 2008 at 12:08 PM PDT.

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Comment Preferences

  •  Where's the part where you explain how (5+ / 0-)

    "It will be all our fault"?

  •  as an econ grad student, can you tell me (3+ / 0-)
    Recommended by:
    joeshwingding, Blogvirgin, diddosMN

    why rescuing the homeowners directly wouldn't work?  Why rescue the guys who created the game instead of the victims of the game?

    What a Progressive Bailout Would Look Like

    •  Well, (4+ / 0-)
      Recommended by:
      Sanuk, LookingUp, orca43, SharpElbows

      what you're proposing is like feeding everyone in the world by giving them one good meal. It's fine for the nonce, but in six hours they'll be hungry again, and we'll still have the exact same problem.

      What we need is to fix the system, not the effect.

    •  Many of those mortgages... (2+ / 0-)
      Recommended by:
      orca43, SharpElbows

      were DOA, and couldn't/can't be saved no matter what.

      Also, directly rescuing homeowners will NOT solve the credit problem, which extends further than most people think.  Farmers, school systems, and many businesses of various types, all of which get their money in a chunk once a year, NEED credit to survive.  It is not a question of living within their means--they are.  They just need credit to do it.  A credit crisis would also hurt people who are fiscally responsible but still rely on student loans to get an education or car loans to get a vehicle.  A lot of those are fairly small loans and easy to pay down, but they make the difference between being able to afford education or a car and not being able to.

      It bothers me how many people on this site really, truly don't understand how vital credit is, or the fact that a stock crash doesn't hurt only people with investments.  Market crises have a ripple effect.

      McCain/Polonius '08! "...They say an old man is twice a child."~~Hamlet II, ii

      by Elsinora on Tue Sep 30, 2008 at 12:27:54 PM PDT

      [ Parent ]

    •  I'm not a econ grad student, but . . . (3+ / 0-)
      Recommended by:
      SingularExistence, Sanuk, math monkey

      it is my understanding that if we gave the money to homeowners - it would not solve the credit freeze.  Right now the credit market is essentially frozen - banks are nervous about lending to anyone (even other banks).  If this continues - banks will not only stop (or reduce) lending to the companies that you work for (which would reduce economic growth and potentially put more negative pressure on this bad economy), but they would also stop lending (or reduce) lending to you (in the form of credit cards, mortgages, car loans, small business loans, etc.).  In order to "unfreeze" this market - the banks need to get rid of their bad debt so that they can start lending to each other, and to keep lending to businesses and individuals.

      If we just gave the money to people with mortgages - the money would only trickle back to the banks - which would only extend the credit "freeze."  Further - it may only delay the problem as some mortgage owners might be able to last a little longer - and once the bailout money runs outs (the Gov't can't pay for everyone forever) these defaults would still take place.

      Now - as I said - I'm not an econ grad student - but that's my understanding.

    •  part of it is just timing (4+ / 0-)

      Banks have already lost money on the mortgages (which means less to lend out).  
      Also, In order for the borrower-side relief to work, the gov't has to guarantee that borrowers won't declare bankruptcy (or pay any less of their mortgage).  This would be incredibly costly as anything like that would be taken advantage of by those that don't need it (how would the government stop someone who can afford to pay, but has lost so much equity in their home that they would rather declare bankruptcy than pay).

      McCain - Ready to follow Osama to the gates of Hell but apparently not into Pakistan.

      by khassani on Tue Sep 30, 2008 at 12:30:28 PM PDT

      [ Parent ]

    •  Because the problem isn't the mortgages. (1+ / 0-)
      Recommended by:

      I feel like screaming into the wind!

      The problem is the credit derivatives!

      The problem is a multi-trillion dollar accounting con that is going to bring down the entire house of cards. Econ student pretends it isn't - most everyone pretends that this has something to do with the first order investments.

      How can a 1% foreclosure rate bring everything down? How? It can't! It's the deals made on top of them!

      •  thanks. (0+ / 0-)

        "How can a 1% foreclosure rate bring everything down? How? It can't! It's the deals made on top of them!"

        Thanks, that answers the conservative talking point about Clinton causing this through his low-income housing initiatives.

  •  What we have is a patient in the ER (5+ / 0-)

    who needs to be stabilized before he can be cured.  I agree entirely with you.

  •  Here's a practical question (2+ / 0-)
    Recommended by:
    Loquatrix, kyril

    to bring things down to a concrete level.

    I feel an enormous impulse right now to withdraw whatever money we are keeping short term out of banks and money market accounts right now. I know this contributes to the problem, but I'm very worried about losing the principal, or not being able to get to it when we need it.

    It's a really sorry state that we've come to when hiding cash under your mattress looks like a half way decent alternative.

    I wish I could open up an account at Gringott's -- nobody's getting past those goblins.

  •  Good diary (4+ / 0-)

    Although like most pro-diaries it argues only for the need to do something--which comes pretty close to swatting at strawmen.

    What's needed are more pieces (a single piece?) explaining why it should be this approach and not others, why the risk of doing nothing outweighs the risk of doing it poorly, etc.

    •  well... (1+ / 0-)
      Recommended by:

      I think your last sentence is the reason I didn't mention a specific solution.  There are definitely better solutions than the bill that failed, but there are an infinite number (including the one that failed) that are better than nothing.

      McCain - Ready to follow Osama to the gates of Hell but apparently not into Pakistan.

      by khassani on Tue Sep 30, 2008 at 12:35:05 PM PDT

      [ Parent ]

      •  Why? (0+ / 0-)

        The knee-jerk attitude among liberal supporters of the current proposal is that there are better solutions out there but that this is better than nothing.  I don't agree.  If this is viewed as a quick-fix necessary to deal with the short-term credit crisis we are facing, and not a long-term solution to structural problems in our financial system, why isn't the simplest solution the best one?  This proposal is to simply buy the illiquid assets that are clogging the system and restraining the flow of credit.  The assets are obviously worth something, and the Federal government will eventually recover at least a significant part of the expenditure.  This approach minimizes the extent of the Federal government's entanglement with financial institutions which either don't require Federal intervention because they are fundamentally healthy, or are fundamentally diseased institutions that probably ought to fail.  This proposal also has the minimum administrative costs of any proposal I have heard and it has the minimum downside risk to the government - essentially it has no downside risk other than the initial cost.  By contrast, having the government assume equity positions in financial institutions has enormous downside risks, particularly since bankruptcy cannot be discounted as a possibility for many of these institutions.  As for the suggestion of advancing money on the underlying mortgages, aside from the fact that it does not really deal with the problem, as the diarist aptly explains, such a program would be enormously expensive to administer since you would put the government in the position of having to evaluate who is a good credit risk and who is not.  Obviously, there is no agency of the federal government currently equipped to do that so you are talking about something that can't be done in the short-run, and it would be extremely expensive to set up and staff a federal agency to perform this function.
        Good diary.

        •  thanks (0+ / 0-)

          but I think there are those that would disagree w/ you on the value of the underlying mortgages.  If there was certainty (or even high probability) that the mortgages will retain their value, then there would be a market solution.  The problem is that the market isn't valuing the mortgages high enough to alleviate the problem.

          McCain - Ready to follow Osama to the gates of Hell but apparently not into Pakistan.

          by khassani on Tue Sep 30, 2008 at 01:23:37 PM PDT

          [ Parent ]

          •  I Wasn't Proposing A Market Solution (0+ / 0-)

            I was proposing essentially what is in the current legislation, namely, having the Federal government purchase the various instruments such as mortgage-backed securities that are currently unmarketable.  However, it is almost certainly the case that they are worth something, and over time there is even some possibility that they will turn out to be worth as much as the Federal government paid for them.  Again, this strikes me as the cleanest and quickest way to restore some immediate liquidity to the system.

            •  miscommunication (0+ / 0-)

              I wasn't suggesting that you wanted a market solution.  I was just giving you the reason a lot of economists don't like the current solution.  They consider the mortgages to a certain loss.  The equity solution would be more expensive, but would have much greater returns on the investment.  I agree w/ you though, that this is not very palatable in the U.S.

              McCain - Ready to follow Osama to the gates of Hell but apparently not into Pakistan.

              by khassani on Tue Sep 30, 2008 at 01:44:57 PM PDT

              [ Parent ]

              •  Taxation (0+ / 0-)

                I'm not that enthused about the Federal government gettting into the money-making business.  I go into this on the assumption that this will be a net cost to the Federal government, although almost certainly not a dollar-for-dollar expenditure.  As for the possibility of an upside, my view is that if Wall Street makes money out of this, then the best way of dealing with that is through taxation, and hopefully after Obama becomes President, we will have some progressivity restored to our tax system.

  •  Let us liquidate our 401Ks! (2+ / 0-)
    Recommended by:
    joeshwingding, kyril

    I have another approach. I'm of the opinion that the problem is not a liquidity crisis, underlying it all it is a debt crisis. Thus, taking on additional sovereign debt will only compound the problem. IOW: derivatives and credit default swaps and all that other paper investment crap was worthless to begin with, which is why it is still worthless today. Giving Wall Street a shit-ton of money to hopefully "bail out" their cash-flow crisis will only flood the economy with money for a short term. And then we'll be back to square one, but only with a whole bunch more additional debt to handle.

    So, if you think the stock and bond markets are going to tank (or stay flat) for the next decade, and you think they're trying to inflate us out of this mess by printing more dollars, the last place you want your money is locked away in a 401K that only allows an investor to bet on market upswings. IOW: in this market, a 401K exists only to lock your money up in an account you barely control, so that wealthy professional investors can get the hell out while leaving you holding the bag.

    So, let us individual investors get the hell out while we can. And do it responsibly. Don't force the 401K holder to wait until they've quit or been laid off: let them liquidate immediately while still employed. Don't make individuals pay the 10% penalty. Instead, offer to allow liquidation if the investor is willing to stream all funds straight in to their home mortgages to pay down debt. Or, to refinance out of a bad variable interest rate ARM or HELoC loan and into a standard fifteen to thirty year fixed rate mortgage or jumbo mortgage.

    This is the way to solve a debt crisis: by paying down outstanding debt. And then all those Wall Street assholes can go declare bankruptcy like everyone else does when they fuck up their businesses.

    "This is the twenty-first century. Nations don't just go invading other countries." --John McCain, said without a hint of irony.

    by maynard on Tue Sep 30, 2008 at 12:18:59 PM PDT

    •  about refinancing (0+ / 0-)

      Allowing that doesn't solve the problem.  It still decreases the value of the mortgage from the view of the bank.  That's the problem we already have.  The mortgage values (again from their PoV) are less than how much they gave.

      McCain - Ready to follow Osama to the gates of Hell but apparently not into Pakistan.

      by khassani on Tue Sep 30, 2008 at 12:38:40 PM PDT

      [ Parent ]

  •  nobody seems to know exactly who is holding ... (3+ / 0-)
    Recommended by:
    Cassandra Waites, kyril, maxxdogg

    the bad paper. It's been swapped around so much, it isn't clear now how to match up paper to real property. I see nothing in the bail out plan that addresses this problem.

  •  Here's what might happen: (1+ / 0-)
    Recommended by:

    by Professor of European Political Economy, London School of Economics and Political Science; former chief economist of the EBRD, former external member of the MPC; adviser to international organisations, governments, central banks and private financial institutions.

  •  Disagree (3+ / 0-)
    Recommended by:
    kyril, llamaRCA, maxxdogg

    I understand the philosophy that government shouldn't be responsible for bailing out Wall Street's mess.  I don't agree w/ it, but I understand.

    Ummm, you mean that you believe government "should be responsible for bailing out Wall Street's mess?"

    Even if one believes that some sort of bailout/rescue needs to be passed, I'd hardly go so far as to say it "should" be responsible.

    BTW, I took some graduate econ as well, and I'm not impressed.  Most of the mainstream economists until recently were swearing on a stack of Milton Friedman's collected works that this could never happen.

    And also, I'm getting tired of the "straw man" being set up in these diaries.  Almost all of us who opposed this bailout, opposed it precisely because of its terms, not because we oppose everything indiscriminately.  We just don't think Congress needs to run around like Chicken Little, screaming, "enact a blank check now!  Now!  Now!!!"

    "When the going gets tough, the tough get 'too big to fail'."

    by New Deal democrat on Tue Sep 30, 2008 at 12:23:57 PM PDT

    •  Polls would say otherwise (1+ / 0-)
      Recommended by:

      In regard to your first argument: I think it's just a semantic argument.  I'm talking about this case.

      As to the "straw man" argument:  the polls show that a large portion of the population (if not majority) are against any government intervention.  Like I said, the market won't collapse tomorrow, but w/o government intervention, I wouldn't be surprised if it did so before the new year.

      McCain - Ready to follow Osama to the gates of Hell but apparently not into Pakistan.

      by khassani on Tue Sep 30, 2008 at 12:44:42 PM PDT

      [ Parent ]

  •  Bush is the boy who cried wolf...only this time (1+ / 0-)
    Recommended by:

    there really is a wolf in the forest.

    "...the fundamentals of our economy are strong"- John Sidney McCain 09/15/08

    by Shhs on Tue Sep 30, 2008 at 12:24:20 PM PDT

  •  Thank you for your diary. I personally needed to (5+ / 0-)
    Recommended by:
    zane, Sanuk, Shhs, venezia, SharpElbows

    hear at least one rational voice in this chorus of stupidity and idiocy that grabbed this blog lately.

    Keep laboring in the grad-school. I remember my days when i was graduate student in mid-1960s. It isn't easy and there is plenty of stress and confidence crises, and questions like: am i doing something valuable and important? Am i really contributing to the literature? and so forth. However, i would tell you to put your head down, ignore that little voice, master the method part of your field, and then take your time writing your dissertation because, i am sorry to say this, the job market is going to be tight, very tight. I hope that your committee is not pushing you to finish early and jump in the job market too soon. One more thing if i may, publish at least one article in the top a tier journals in your field before you go on the job market. It will help you tremendously and differentiate your application from the others. When i used to sit on the hiring committee, i always favored those who published over those who did not because it is an indicator of someone who is going to make it through his tenure clock and rise from assistant to associate.

    Good luck to you and again thanks

    Don't give a damn a/t each & every politician currently alive in the US. Last time i voted for the top part of the ballot was 1972. Never missed SB election

    by Mutual Assured Destruction on Tue Sep 30, 2008 at 12:25:58 PM PDT

  •  Here's my problem (3+ / 0-)
    Recommended by:
    MadRuth, kyril, maxxdogg

    After we avert disaster

    What makes you think this will avert disaster? What makes you think Paulson will use this money in a responsible manner? You have to trust him for this plan to work.  I don't. At a minimum we MUST have more oversight and control over how this money is going to be used.

    Your whole argument is based on an assumption.

  •  Grad student...go study econ history (1+ / 0-)
    Recommended by:

    bailouts and loans to investors rarely stem economic downturns. They are stop-gap measures that boost already-affluent incomes, but after the initial burst, they don't create the problem. Income and demand drives the markets in the real economy. With job losses increasing, and incomes stagnant, that is what needs boosting.

    •  ...lookup what (1+ / 0-)
      Recommended by:

      people like Barry Eichengreen and Ben Bernanke (two of the leading scholars of the Great depression) wrote about as being key factors in sustaining the Great Depression.

      Both of them would very much agree with this post.

    •  Here's some history: (1+ / 0-)
      Recommended by:

      First of all, we are and will be in a recession (not by the formal definition, but by realistic ones) for the time-being.  This will not change that.  This is simply to stop things from getting worse.

      On to the history part:
      Governments actually have had a lot of success w/ bailouts.  Sweden in the 1990's for example.  Their solution was much more equity driven, but I'm not sure how politically viable that is in the U.S. (the idea of government stakes in banks may scare enough of the right to kill this idea).

      McCain - Ready to follow Osama to the gates of Hell but apparently not into Pakistan.

      by khassani on Tue Sep 30, 2008 at 12:59:59 PM PDT

      [ Parent ]

  •  a couple of questions (0+ / 0-)

    Since you are a grad student, can you give us another diary with a comparison between the Swedish and Japanese bailout models. It is my understanding that Sweden was much more successful bailing out only the strong banks, while the proposed bailout follows more closely the failed Japanese model. What makes you think we will not go the way of Japan here, with the weak leadership and lack of ideas that we have at the top?

    Also, what are your thoughts about the CDS market, that seems the more intractable and dangerous problem. Banks should not be wiped out by taking a 20-30 percent loss on their mortgage loans after foreclosure, there is a much more general failure in progress.

    Law is a light which in different countries attracts to it different species of blind insects. Nietzsche

    by Marcion on Tue Sep 30, 2008 at 01:19:13 PM PDT

    •  not the right person to write that diary (0+ / 0-)

      It's not my area.  I'm only familiar w/ Japan and Sweden as examples b/c they were brought up as examples by a professor.  As I noted above, the Japanese government failed to act fast enough.

      I think there has certainly been issues w/ accounting fraud, and hopefully that will be investigated.  However, given the low reserve requirement (the ratio of cash banks have to have for all the loans they have), a loss of 20-30% would have a huge impact (actually the 20-30% seems to be rather high; I don't know what the amount is, but 20-30% loss by itself would be pretty devastating).

      McCain - Ready to follow Osama to the gates of Hell but apparently not into Pakistan.

      by khassani on Tue Sep 30, 2008 at 01:40:51 PM PDT

      [ Parent ]

  •  Everyone gets $5,000 in my bailout plan! (0+ / 0-)

    If we are going to bail out the bankers for the tune of one trillion and go into debt for it, I say we send everyone who earns under $200,000 a year a check for $5,000, and add another one trillion in debt.  All of this new money into the economy would be a big boost to the economic engine, help a lot of people out, and no one would really object to it.  I'm an MBA in econ as well, and if the repugs object, let the dems vote this in without them, and we'll have a democratic government for many years into the future.

    Like this idea?

  •  Don't know about your economic studies... (0+ / 0-)

    ...but you definitely need to bone up on your George Bailey:

    Joe, you had one of those Potter houses, didn't you? Well, have you forgotten? Have you forgotten what he charged you for that broken-down shack? Here, Ed. You know, you remember last year when things weren't going so well, and you couldn't make your payments. Well, you didn't lose your house, did you? You think Potter would have let you keep it?


    No, but you . . . you . . . you're thinking of this place all wrong. As if I had the money back in a safe. The money's not here. Your money's in Joe's house . . . (to one of the men) . . . right next to yours. And in the Kennedy house, and Mrs. Macklin's house, and a hundred others. Why, you're lending them the money to build, and then, they're going to pay it back to you as best they can. Now what are you going to do? Foreclose on them?

    And, finally...

    I don't need 24 hours. I don't have to talk to anybody. I know right now, and the answer's no. No! Doggone it! You sit around here and you spin your little webs and you think the whole world revolves around you and your money! Well, it doesn't, Mr. Potter! In the, in the whole vast configuration of things, I'd say you were nothing but a scurvy little spider!

    p.s. Great-grandson George Bailey Paulson, 2008...

    No, but you . . . you . . . you're thinking of this place all wrong. As if I had the money back in a safe. The money's not here. Your money's been lent to someone who couldn't afford to pay it back so they could buy an overvalued house, then that loan was sold based on the value of the money that we'll never get back again plus interest, and then packaged and securitized and swapped and derivatized until there was so many fingers in it that your deposit ended up as our profits and you're never gonna see a dollar of it unless you give us more money so we can give you back the money you deposited, and then we'll loan that money out and then you'll get some of it back, maybe.

    The fact is that the average man's love of liberty is nine-tenths imaginary, exactly like his love of sense, justice and truth. - H.L. Mencken

    by two roads on Tue Sep 30, 2008 at 01:34:59 PM PDT

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