The Bailout Bill is needed by Main Street as much, or more, than Wall Street. Yet support for this Bill carries significant risk for the Democrats. That is why a full understanding of the advantages of the Plan, and the risks of no plan, is crucial.
The question we must be able to answer is why taxpayers ought to provide support for a problem caused by the greed and recklessness of the financial services sector.
Answer below the break.
Two Origins of the Problem; Excess money and lack of regulation: As Bill Clinton brilliantly explained on the Daily Show Sept. 23rd, one of the causes of the problem was the success of the Clinton economy. There was simply too much money chasing too few opportunities. The only way you could make money was in housing.
The second cause was the failure of the laissez faire Republican administration and executive branch to either identify or regulate the excesses, and instead rely on the free market to work things out.
The problem is real and significant If the problems weren't very serious, there is no way the Bush administration would risk being labeled as socialists. As G.W. Bush stated:
My first instinct was to let the free markets work...until I realize that they couldn't.
If handled properly, the Bailout Bill can make the taxpayers money
According to this week's This Week's Barron's Cover Story
Of the $1 trillion presumed hole, $800 billion involve subprime and Alt-A mortgage securities, which are of slightly higher quality than subprime. The remainder of losses is accounted for by under-water prime mortgage securities and unsecuritized mortgage loans.
... [T]he amount that conceivably could be sold to Treasury is about $800 billion. If the government buys that for 65 cents on the dollar, the price is $520 billion. Uncle Sam ... could then earn perhaps 7% net on that for each of two years, pocketing about $75 billion. Then, assuming the housing and securities markets have stabilized somewhat, the government should be able to sell the securities for something more than 65 cents, recouping its initial investment and then some.
So from a purely investment standpoint, the Bailout Bill should actually make money. Other financial analysts have pointed out that if the ecomony improves and there are fewer defaults, the payout to taxpayers could be even greater. An example of the hidden quality in today's mortgage securities on offer.
[TCW'S GUNDLACH in Barron's] said he recently paid 50 cents on the dollar for a triple-A piece of a 30-year fixed subprime mortgage pool that came from the horribly performing vintage period of early 2007. Even assuming a severe acceleration in loan delinquencies, a 66% loan default rate and a skimpy 20% recovery on any foreclosures, he contends that the tranche will produce a yield of over 12% and principal pay-back of nearly 70 cents on the dollar. If only half the mortgages in the pool default, then its yield would jump to 14.2%.
If the expected default rate is lowered to 30% and the foreclosure recovery rate rises to 40%, the Treasury could pay 100 cents on the dollar, or par, and still get a positive return and according to Gundlach, all their principal back.
The liquidity crunch, if not restrained, threatens to pull down the entire financial sector.
Fire sale pricing ... has spawned the current liquidity panic and caused credit markets to seize up. As the buyer of last resort under the bailout plan, Treasury hopes to reverse market psychology. Rather than prices being set by the last panicked buyer attempting to get liquid at any price, they would be dictated by the actual prospects of the mortgages underlying the securities and the cash flow they throw off.
Fed Chairman Ben Bernanke stated that the government would seek to shift the pricing in the mortgage-securities market from fire sale to "hold-to-maturity" levels.
Many probably do not recall the Savings and Loan collapse (something John McCain would not like to remember, either (think Keating Five)). In that debacle the excess money went to Savings and Loans and another Real Estate bubble. The Resolution Trust Corporation basically stopped the run and collapse of Savings and Loans around the country, taking over the banks themselves, then painfully working through their inventory of mortgages and investments.
This Bill is much less expensive, and in the long run should be more effective. By inacting the Bill now, we can avoid a run on the banks that will result in much higher overall costs and much more damage.
Many rank and file middle class folks have much of their wealth in pensions. Whether those assets are in 401(k) plans or company managed plans, the effect of a collapse is the same and could lead to the plan sponsors themselves going under in an effort to meet their obligations. The net result: pensions would be wiped out.
The principal from all of this?
No man is an Island, entire of itself; every man is a piece of the Continent, a part of the main; if a clod be washed away by the sea, Europe is the less, as well as if a promontory were, as well as if a manor of thy friends or of thine own were; any man's death diminishes me, because I am involved in Mankind; And therefore never send to know for whom the bell tolls; It tolls for thee.
John Donne, Meditation XVII
English clergyman & poet (1572 - 1631)
You would think that by now our civilization would readily accept the necessity for oversight and regulation. But we continue to repeat the boom and bust cycles every 20 years or so, as the money runs into the unregulated nooks and crannies.
Even Barron's admits that regulation and restraint of free enterprise is necessary:
While we worship unfettered free enterprise, occasionally the Adam Smith invisible hand goes spastic and must be restrained.
This leads me to the following conclusions:
All progressives should support the Bailout Bill (with all the additional protections that our Congress can get, such as limits on executive pay, etc.).
We must fully understand and emphasize that the Bill was required because those in power failed to regulate the excesses of the free market.
We ought to try to institutionalize a way to identify and stop future bubbles and thereby avoid their collapse.
We should make the conservatives admit that government has an important role to play, and crush John McCain's "less regulation is better" policy.
Update: here is a description of the latest version of the Bill:
Under the plan, the federal government would purchase mortgage-backed securities and other bad debts held by banks and other investors. The money should help troubled lenders make new loans and keep credit lines open. The government would later try to sell the discounted loan packages at the best possible price.
At the insistence of House Republicans, some of the program's $700 billion would be devoted to a program that would encourage holders of distressed mortgage-backed securities to keep them and buy government insurance to cover defaults.
The legislation would place "reasonable" limits on severance packages for executives of companies that benefit from the rescue plan, said a senior administration official who was authorized to speak only on background.
It also calls for the financial sector to help make up the difference if the government does not recoup its investment in five years, the official said, but details remained unclear.
Also, the government would receive stock warrants in return for the bailout relief, giving taxpayers a chance to share in financial companies' future profits.
To help struggling homeowners, the plan would require the government to try renegotiating the bad mortgages it acquires with the aim of lowering borrowers' monthly payments so they can keep their homes.
Despite the changes made during an intense week of negotiations, the heart of the program remains President Bush's original idea: spend billions of taxpayer dollars to buy mortgage-backed securities whose value has plummeted.